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UCL ECON1005. THE WORLD ECONOMY. Hugh Goodacre.

8. FROM POST-WAR KEYNESIANISMTO WASHINGTON CONSENSUS.

Post-war Keynesian consensus, 1944-75.(a) Industrialised countries.(b) Developing countries.

The idea of development, 1945-84.

Pressure for a New International Economic Order, 1970s.

Washington Consensus: the pendulum swings back.Shift to LR perspective.Critique of Keynesian demand management policy.

e.g. Poor record of UK. Pressure for NIEO weakens.All-round reversal of Keynesian approach.

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The 1930s: Keynes as oppositionist

Keynes in GT: “Ricardo conquered England as completely as the Holy Inquisition conquered Spain”.

[David Ricardo (1772-1823): prominent representative of classical economics.]

i.e. Keynes saw himself as embattled oppositionist facing entrenched classical orthodoxy.

Post-war period: the orthodoxy changes

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BUT

• During World War 2, Treasury came round to Keynes’s view

• Keynes led UK negotiations:

• for war-time loans from US

• for post-war global reconstruction

• Till mid-1970s, Keynesianism was to be the new orthodoxy!

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Keynes was chief British negotiator at 1944 international conference at Bretton Woods in New Hampshire, US.

• Aim of conference was to map out post-war economic order.

• Laid foundations for establishment of:

• International Monetary Fund (IMF)

• World Bank (International Bank for Reconstruction and Development)

• eventually (after half a century of ‘rounds’ of negotiations) the World Trade Organisation (WTO)

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0

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1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Great Depression: winter 1932-3, unemployment 3 million / over 22%

Two traumatic periods for the UK macroeconomy

Stagflation 1970s

WW1 1914-18

WW2 1939-45

Post-war boom1945-

early70s

Early 90s recession

Early 80s recession

Unemployment in the UK,1880-2005.

Post-war Keynesianism

Classical revival

Regular cycles

1936: publicationof GT

Consensus macro?

‘NICE’

Note 3 successive dominant currents in post-war macro

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From Keynes to post-war Keynesianism

Keynes:

Investment behaviour (principal cause of fluctuations) cannot be ‘modelled’ in simple way

e.g. Determinants if I are unpredictable:

expectations, mood (opti-/pessimistic), ‘animal spirits’, etc.

Post-war Keynesianism became the orthodoxy / textbook macro.

e.g. Phillips Curve appeared to be stable – a policy ‘menu’.

Simply choose whether u or π is problem at given moment:

High u → reflationary measures.

High π → deflationary measures.

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1919 1921 1923 1925 1927 1929 1931 1933 1935 1937

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-20

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-10

-5

0

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15Unemployment

Inflation

Unemployment and inflation go in opposite directions during this period.They show an ‘inverse relationship

Infl

atio

n %

Un

emp

loym

ent

% o

f w

ork

forc

e

Negative inflation is termed deflation

UK unemployment and inflation: inverse relationship, 1919 - 38

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The Phillips Curve

Unemployment and (wage) inflation, 1861-1913.From Phillips’s 1958 article.

fig

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1919 1921 1923 1925 1927 1929 1931 1933 1935 1937

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-10

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0

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UK unemployment and inflation: 1919 - 38UK unemployment and inflation: 1919 - 38

Unemployment

Inflation

Unemployment and inflation go in opposite directions during this period.They show an ‘inverse relationship

Infl

atio

n %

Un

emp

loym

ent

% o

f w

ork

forc

e

Negative inflation is termed deflation

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Post-war Keynesianism, 1944-75: the global dimension.

(a) Industrialised countries. Consensus uneasy.

• Demand management / sustain global demand / prevent new Depression.

• Deficit financing OK if economy slows down.

• Reduce tariffs / prevent new breakdown in trade.

Europe: State intervention -- prestige high:

• Soviet 5-year plans, war-time planning in Western Europe.

US: less positive about intervention / active Demand Management Policy.

• Tariffs: powerful US protectionist lobbies.

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(b) Developing countries. Consensus favourable:

Sustaining global demand

IMF: Deficit financing (on a global scale).

Opposite of its role later!

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The idea of development, 1945-84.

• 19th century: develop natural resources of colonies.

• Oxford, late 1930s: development economics → academic syllabus: in ‘Colonial Studies’ course.

• Post-war: from training colonial administrators to training their replacements!

Characteristic topics:

• Relation between subsistence and commercial sectors (or ‘traditional and modern’).

• Relation between town and country.

• Relation between manufacture and agriculture.

• Obstacles to the consolidation of wage-earning labour force.

• Influence on economic life of traditional society and culture.

Irony: Latin America: focus of much of the theoretical activity.East Asia: principal claim of an actual ‘success story.

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Pressure for a New International Economic Order, 1970s.

Terms of trade (TOT):

TOT ≡ PX / PM

Deteriorating commodity terms of trade:

Example: Say we have a country where:

90% of its exports are coffee.

90% of its imports consist of agricultural machinery.

i.e. The country’s TOT is clearly dominated by:

Pcoffee / Pmachinery

Now suppose:

Pcoffee slumps but Pmachinery soars.

→ TOT suffers a drastic deterioration.

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‘Prebisch-Singer Hypothesis’:

e.g. Real agricultural raw material prices, 1968-2002

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Percentage of trade within own region, 2002:

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WesternEurope

North America Asia Latin America Africa

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From early 1960s: Newly independent countries enter UN, etc.

→ International institutions had to respond / take development issues on board:

1968-1981: Declared aim of World Bank was to alleviate world poverty.

(From early 1980s, focus shifted to debt management.)

1986 / Uruguay (8th) round:

Declared aim was to bring developing countries into the institutions’ decision-making process.

Pressure for a New International Economic Order.

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70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

$ per barrel

Actual priceCost in 1973 prices

Yom KippurWar: Arab oil

embargo

First oil fromNorth Sea

Revolutionin Iran

Iraq invadesIran

OPEC’s firstquotas

Cease-fire inIran-Iraq war

Recessionin Far East

Iraq invadesKuwait

New OPECquotas

World-widerecovery

World-wideslowdown

Impendingwar

with Iraq

Rapid growthin demandfrom China

Oil PricesOil Prices

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

Critique of Keynesian demand management policy:

US: Keynesianism / post-war consensus always grudging acceptance anyway.

UK: UK Conservative Party:

•Final fling of expansionary demand management, early 1970s.

•Under Conservative (Heath) government – ‘Barber boom’.

•Then reaction against this: Thatcher leader (1975), PM (1979).

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

Critique of Keynesian demand management policy:

Keynesianism / post-war consensus breaking down, early 1970s:

Critics of Keynesianism were now pointing out:

Breakdown of Phillips curve.

Friedman (‘monetarism’) claimed by to show futility / destabilising effect of Keynesian demand management policy.

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‘Stagflation’: Breakdown of the stable Phillips Curve.

From late 1960s, negative relationship between u and π no longer evident

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

Critique of Keynesian demand management policy:

A major argument (UK but international influence):

Keynesian policies particularly dominant in UK.

But relatively poor performance of UK economy.

Poor growth relative to other industrialised countries.

‘Stop-go’ / instability – amplitude of fluctuations.

Stagflation (collapse of Phillips Curve) particularly severe.

BOT problems particularly intense.

See Sloman chapter!

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

Pressure for NIEO eases.

Bargaining power of newly-independent countries losing force from mid-80s.

Global political developments:

Iran-Iraq war.

Faltering then collapse of Soviet Union, etc.

East Asian examples of rapid growth through integration with omk-dominated market system > confrontation / contention.

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

By the early 1980s, a ‘Washington Consensus’ had become dominant in the IFIs.

i.e. IMF

WB

US Treasury as well? (claimed / emphasised by critics)

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Classical counter-attack: ‘Washington Consensus’, 1975-96.

i.e. Reverse Bretton Woods / Keynesian consensus.

→ All-round classical revival:

minimise role of government

reduce taxes / balance budget

eliminate impediments to free flow of capital

liberalise trade

privatize state-owned enterprises.

‘Washington Consensus’:

Expression of this classical revival at international level.

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The two main macroeconomic traditions – overview

The General Theory of Employment, Interest and Money. 1936

‘Classical’ assumptions: full employment / scarce resources.

Keynesian critique:

Resources not scarce: unemployed workers, idle factories

Problem was lack of effective demand.

Unemployment prolonged → “all dead” before long-run equilibrium.

→ intervention / stimulate demand in recession

25YR

P1

AD1

P

Y

AD2

P2

YFE

AS

P3

AD3

AD4

P4

Keynes and classical economics

BUT if economy is at YFE (“special case”), then “classical economics comes into its own again”: resources are scarce / only effect of Y↑ would be P↑.

Keynes: Range where economy may settle [ be in ‘equilibrium’] at Y < YFE (e.g. YR); AD↑ can → Y↑ with little effect on P; government boost to AD justified?

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1999 per capita output

Years to attain US 1999 level( $30,600)

1% growth

3% growth

6% growth

9% growth

Actual growth rate (1990-99)

Germany 25,350 20 7 4 3 1.5

UK 22,640 32 11 6 4 2.1

Brazil 4,420 196 66 34 23 1.7

China 780 370 145 64 44 9.8

Ethiopia 100 577 194 99 67 2.2

Small difference in growth rate can have massive effect in LR:

Classical counterattack: arguments for shift to LR perspective:

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Classical counterattack: arguments for shift to LR perspective, contd:Cross-country comparison of growth in output per worker since 1870:

LR Growth rate: the supply-side emphasis:Has begun to rise at different points in time (‘take-off’).Has then continued at different rates.

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Nat

iona

l out

put (

Y)

Time

Actualoutput

Trendgrowth

Fluctuates with the course of the business cycle -- upturn, expansion, peaking-out, slowdown / recession.

Classical revival / ‘supply-side economics’ /counter-attack against post-war Keynesianism:

the issue of long-run growth.

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i.e. Illustrates classical revival / critique of post-war Keynesian consensus:

Post-war consensus

Theoretical basis

Macro / Keynesian

Issues centralised

Fluctuations / business cycle

Time horizon SR

S-side or D-side Demand-side

GoalStabilisation over the

cycle

Policy stance Interventionist

Classical revival

Micro / classical

Growth

LR

Supply-side

Improvement in Supply

Laissez-faire!

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The two main macroeconomic traditions - review:

Classical economics.Nearest to micro tradition:

Growth theory: micro modelling.TCA: note: particular commodities; FE assumption.

Emphasis on supply.e.g. Free trade versus intervention debate (List vs. Smith-Ricardo, etc.) concerned supply effects.

Post-war [Keynesian] consensus.Keynesianism / demand management / interventionism.

Washington [Classical] Consensus.Classical / classical revival – Friedman’s ‘monetarism’, etc. / supply emphasis / laissez-faire.

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Themes.

Keynesian critique of classical (micro / S-side) economics (“applicable to a special case only”).

History of economic ideas is essential to assessing their analytical power.

Validity of entire framework of today’s macro (Philips Curve, economic cycles, etc.) being tested in current conditions (emerging economies, financial implosion).