ECONOMICS AND POLICY FOR SUSTAINABLE AND INCLUSIVE GROWTH
Edited by M. JACOB and M. MAZZUCATO
“A fine collection of chapters by leading progressives on what went wrong — low growth, flagging investment and innovation, too few jobs and too much carbon — and what might be done. May it close the door on the failed “mainstream” and open another, toward a fully-integrated, uncompromising, radical view of economics and economic policy.” James K. Galbraith
Table of Contents
1. Rethinking Capitalism: An Introduction
MICHAEL JACOBS and MARIANA MAZZUCATO 1
2. The Failure of Austerity: Rethinking Fiscal Policy
STEPHANIE KELTON 28
3. Understanding Money and Macroeconomic Policy
L. RANDALL WRAY and YEVA NERSISYAN 47
4. The Costs of Short-termism
ANDREW G. HALDANE 66
5. Innovative Enterprise and the Theory of the Firm
WILLIAM LAZONICK 77
6. Innovation, the State and Patient Capital
MARIANA MAZZUCATO 98
7. Investment-led Growth: A Solution to the European Crisis
STEPHANY GRIFFITH-JONES and GIOVANNI COZZI 119
8. Inequality and Economic Growth
JOSEPH E. STIGLITZ 134
9. The Paradoxes of Privatisation and Public Service Outsourcing
COLIN CROUCH 156
10. Decarbonisation: Innovation and the Economics of Climate Change
DIMITRI ZENGHELIS 172
11. Capitalism, Technology and a Green Global Golden Age: The Role
- Giovanni Cozzi
- Colin Crouch
- Stephany Griffith-Jones
- Andrew G Haldane
- Michael Jacobs
- William Lazonick
- Stephanie Kelton
- Mariana Mazzucato
- Yeva Nersisyan
- Carlota Perez
- Joseph E. Stiglitz
- L. Randall Wray
- Dimitri Zenghelis
1 – Rethinking Capitalism – An Introduction
One of the most contentious of those debates has concerned the role of fiscal and monetary policy in response to the financial crisis and the ensuing slow recovery . In their chapters , Stephanie Kelton , and Randall Wray and Yeva Nersisyan take issue with the orthodox prescription of fiscal austerity . Kelton’s argument is that austerity is based on a fundamental economic misunderstanding . The claim that high deficits caused the recession turns the facts on their head : it was the recession which caused deficits to balloon , as the downturn slashed the tax revenues earned by governments and the automatic stabilisers of social security benefits and public spending went into operation . Kelton shows that in fact the deficits prevented the recession becoming much worse , generating demand
Wray and Nersisyan go further . They argue that the orthodox view of macroeconomic policy stems from an incorrect understanding of the nature of money . Rather than being exogenously determined by the central authorities , as the orthodox view has it , money is effectively created whenever commercial banks lend , and thereby increase their borrowers ’ purchasing power . Money is endogenous to the real economy . Examining the operations of modern central banks , Wray and Nersisyan show that for a nation with its own currency , government spending is not constrained by the resources available from taxation or borrowing . 35 The euro zone in particular has suffered from its rules expressly designed to prevent weaker European economies from borrowing in the absence of their own currency . Quantitative easing meanwhile is a poor way of boosting aggregate demand . Fiscal policy , the authors argue , is a much more powerful and effective tool for stimulating growth .
Perhaps unsurprisingly , austerity policies have not succeeded in reversing the low levels of investment
Haldane asks if short – termism in financial markets may have reduced the willingness of firms to invest .
Overall , he concludes that short – termism appears to be making a material difference to corporate investment behaviour .
Lazonick focuses on the orthodox economic theory of the firm . Neoclassical economists draw on a model of the firm as an optimising profit – maker constrained in its behaviour by the competitive markets in which it operates . But such a model cannot explain the phenomenon of innovation .
Lazonick argues that the key is not the nature of the market , but the structure and organisation of the firm .
He argues that only by studying real historical examples , rather than merely abstract theory , can economists properly understand how innovation and economic development occur . Mazzucato’s chapter picks up this theme . The orthodox economic view is that innovation is carried out by the private sector , and government policy should be restricted to basic scientific research . But Mazzucato shows that this is a misconception ; in fact the modern state , particularly in the US , has been a driver of innovation in a whole range of fields .
Griffith – Jones and Cozzi then show what an investment programme based on these principles might achieve .
The chapters by Joseph Stiglitz and Colin Crouch look at two of the major gaps between orthodox economic theory and the reality of modern capitalism . Stiglitz addresses the growth of inequality over the past thirty years . He takes on the neoclassical view that wages and salaries reflect the marginal productivity of workers
Crouch looks at the experience of privatisation and outsourcing .
The final two chapters of the book examine capitalism’s environmental consequences. Dimitri Zenghelis shows why climate change poses such a challenge , not just to the economic system , but also to economics .
Strong and consistent policy – making can help shift investment towards tipping points when innovation may be driven rapidly in a low – carbon direction . Carlota Perez notes that structural change of this kind has happened before .
Nevertheless , their critiques have many elements in common . Each challenges an important aspect of orthodox economic theory and policy prescription .
By ‘orthodox’ we mean the view that dominates public debate about economic policy .
In individual markets , neoclassical theory ( on which the orthodox view is based ) holds that such competition drives economic efficiency , which in turn maximises welfare . Markets are assumed to tend towards equilibrium , while businesses are assumed to be fundamentally alike , analysed as ‘ representative agents ’ constrained to act in the same ways by the external pressures of the market . At the level of the economy as a whole , it is competition between firms which is believed to generate innovation , and therefore leads to long – run economic growth . … The orthodox model understands that markets do not always work well . It therefore uses the concept of ‘ market failure ’ to explain why suboptimal outcomes occur and how they can be improved .
The orthodox model provides an attractively simple framework for thinking about economics and policy . It combines the mathematical elegance of neoclassical microeconomics with plausible claims about the macroeconomy . The fact that many of the policy prescriptions which follow from it favour those in positions of incumbent economic power has given it a powerful grip on public discourse . ./..
But it’s not an adequate model for understanding how capitalism works . For markets are not simple structures which behave in the ways set out in economics textbooks ; and ‘ market failure ’ is not a helpful concept for analysing capitalism’s major problems or how to address them . These idealised theories assume away many of capitalism’s key features , or treat them as ‘ imperfections ’ rather than structural , systemic characteristics . They ignore much of the evidence on how different economies actually function , and when and why they have performed well or badly . None of the key problems which Western capitalism has experienced over recent decades — weak growth and financial instability , declining investment and financialisation , the stagnation of living standards and rising inequality , dangerous environmental risk — are explained by them .
Capitalist economies are not theoretical abstractions but complex and dynamic systems , embedded in specific societies , as well as in natural environments governed by biophysical laws .
For these characteristics of capitalist economies are hardly revelatory . They have been analysed in theory and documented in practice for more than a hundred years of economic scholarship . They underlie the work of some of the greatest economists of the past century — such as Karl Polanyi , Joseph Schumpeter and John Maynard Keynes — and of the more recent schools of evolutionary , institutional and post – Keynesian economics .
Markets are better understood as the outcomes of interactions between economic actors and institutions …. Markets are ‘ embedded ’ in these wider institutional structures and social , legal and cultural conditions . 38 In the modern world , as Polanyi pointed out , the concept of a ‘ free ’ market is a construct of economic theory , not an empirical observation . 39 Indeed , he observed that the national capitalist market was effectively forced into existence through public policy — there was nothing ‘ natural ’ or universal about it .
The orthodox notion of competition between firms is equally misleading .
In fact , the evidence shows the particular importance of ownership and governance structures .
In short , markets are not idealised abstractions , but concrete and differentiated outcomes arising from different circumstances . Contrary to the claims of orthodox economists that ‘ the laws of economics are like the laws of engineering : one set of laws works everywhere ’ , 44 there are in fact many different kinds of market behaviour , and several varieties of capitalism . 45 The second key insight is that it is investments in technological and organisational innovation , both public and private , which are the driving force behind economic growth and development . The diffusion of such innovations across the economy affects not just patterns of production , but of distribution and consumption .
Critically , as Mazzucato shows , innovation also needs well – funded public research and development institutions and strong industrial policies . These need to be directed across the entire innovation chain , not only in the classic ‘ public good ’ area of basic science . A crucial recognition is that innovation has not only a rate , but also a direction . By setting societal missions , and using their own resources to co – invest with long – term capital , governments can do far more than ‘ level the playing field ’ , as the orthodox view would allow . They can help tilt the playing field towards the achievement of publicly chosen goals .
Recognition of the role of the public sector in the innovation process informs the third key insight . This is that the creation of economic value is a collective process .
Indeed , Keynes argued that the ‘ socialisation of investment ’ — which , as Mazzucato suggests , could include the public sector acting as investor and equity – holder — would provide more stability to the investment function and hence to growth .
So the size and functions of the state matter profoundly to the performance of capitalist economies . In orthodox economic commentary it is frequently asserted that the role of the public sector should be minimised in order to free private enterprise from the ‘ dead hand ’ of regulation and the perverse impact of ‘ crowding out ’ . In fact , successful economies have almost all had states actively committed to their development .
We need to acknowledge , rather , the interdependence of private enterprise and the public sector ; of market and non – market activities . This has an important implication for the role of taxation . The orthodox economic view characterises taxation as an essentially negative activity in which the value generated by private firms is confiscated by the state . But understanding the role of the public sector in the co – production of economic output allows a more profound perspective . Taxation is the means by which economic actors pay the public sector for its contribution to the productive process .
This creates a powerful case for the rebalancing of the distribution of earnings between capital and labour .
These three insights therefore have profound implications for how we think about economic policy – making . Public policies are not ‘ interventions ’ in the economy , as if markets existed independently of the public institutions and social and environmental conditions in which they are embedded . The role of policy is not one simply of ‘ correcting ’ the failures of otherwise free markets . It is rather to help create and shape markets to achieve the co – production , and the fair distribution , of economic value . Economic performance cannot be measured simply by the short – term growth of GDP , but requires better indicators of long – term value creation , social well – being , inequality and environment sustainability . 60
3 – Understanding Money and Macroeconomic Policy
Many economics textbooks offer brief accounts of the origins and evolution of money . Some typically note how money reduced the inefficiencies of barter , thereby facilitating the exchange of goods and services , and then go on to describe the evolution of paper money as a promise ‘ to pay the bearer ’ a specified amount of a valuable commodity such as gold or silver in exchange . The available supply of the precious metal set limits on the amount of paper IOUs ( ‘ I – owe – yous ’ ) that could be issued . In turn , there was always a risk of default — failure to pay the valuable commodity if there was a sudden rush to redeem paper for gold .
Eventually , according to this basic account , governments issued ‘ fiat money ’ , that is , national currencies no longer backed by any commodity . But from an orthodox perspective , the problem with fiat money is that there are no natural limits to its supply once it is freed from a commodity backing such as gold . The growth of fiat money can outstrip the growth in the volume of output produced each year in the economy . This creates the danger that excess growth in the supply of fiat money would lead to inflation , with ‘ too much money chasing too few goods’ . This ‘ quantity theory of money ’ , subsequently developed by Milton Friedman , argued that if governments were allowed simply to ‘ print money ’ to finance spending , this would inevitably lead to higher inflation . 7 Consequently , orthodox economists believe that government spending should largely be constrained by tax revenue .
From an orthodox perspective , the quantity of fiat money in existence appears to be ‘ exogenous ’ to the real economy . That is , the supply of money is determined by the central authorities independently and separately from the production of goods and services . This idea lies at the heart of the ‘ classical dichotomy ’ in macroeconomics , where monetary variables are seen as independent of real variables . In the orthodox view an excess growth of this exogenously determined money supply relative to the growth in real output causes a rise in the general price level ; for this reason , controlling the money supply is central to the control of inflation .
But this view of money does not actually accord with the facts . As Hyman Minsky pointed out , money is not created simply by the central authorities . It is effectively created whenever commercial banks lend money , since such lending increases the purchasing power of those who borrow . It is therefore the demand for loans by businesses and households in the economy which determines the money supply . Money , in other words , is endogenous to the real economy , and is not independent of the production of goods and services at all .
Arguing that governments have a choice between debt financing ( which is regarded as unsustainable ) and money financing ( which is seen to be inflationary ) is based on a misunderstanding of how modern governments spend . In fact , both tax payments and bond sales logically come after the government has spent .
So seen from the perspective of modern money theory , sovereign governments do not need to ‘ borrow ’ their own currency in order to spend . They offer bonds on which banks , households , businesses and foreigners can earn interest . They do this out of choice rather than necessity . Governments do not need to sell bonds before they spend ; indeed , they cannot sell them without reserves being in place . Reserves are provided either through government spending ( i.e . fiscal policy ) or through central bank operations ( i.e . lending or open market purchases ) .
While governments do not face financial constraints , they do have to deal with real resource constraints .
Austerity efforts in the US and UK are now rarely done in the name of ‘ controlling inflation ’ . Rather , the case for fiscal consolidation is based on claims that these countries are ‘ running out of money ’ or spending in excess of ‘ hard – working taxpayers ’ money ’ such that governments need to ‘ tighten their belts ’ , as if the government budget were the same as a household budget .
With the collapse of Bretton Woods , for the first time in modern history , all the world’s currencies were de – linked from gold or any other commodity . The lack of any formal constraint on money creation contributed to nervousness about inflation . ’ 13 Orthodox economists , informed by the quantity theory of money , felt that monetary policy – makers should ensure that the quantity of money available in the economy did not contribute to inflation .
The push to mandate central banks to target inflation can be understood as a way to establish some anchor for the value of ‘ fiat money ’ .
Page 55 For proponents of modern money theory , however , this view of the process of bank credit creation , and the accompanying belief that the central bank can control the quantity of money available in the economy , is a fiction . Banks do not in fact lend from the deposits made by households and businesses .
So if the central bank wants to secure its target rate , it will have to supply reserves . This is usually done through an open market purchase , where the central bank buys a security , paying for it with reserves . In the opposite situation , when banks have more reserves than they desire , the central bank needs to drain reserves through an open market sale to prevent the interest rate from dropping below its target .
In sum , while the orthodox view sees central banks as choosing between controlling reserves and controlling interest rates , endogenous money theory argues that interest rate control is in fact the only tool at the central bank’s disposal . The quantity of money in the economy in practice depends on many variables , with interest rates being only one of them . In any case , once one disposes of the quantity theory of money , the stock of money in the economy becomes a relatively unimportant variable . What is important for the economy is the total level of aggregate demand , and the quantity of money does not determine its level , but rather is mostly a consequence of the decision to lend to finance desired spending .
As we saw in the previous section , bank lending is not constrained by reserves
QE is no more inflationary than any central bank open market operation designed to increase reserves in the banking system .
7 – Investment-led Growth: A Solution to the European Crisis
A well – designed pan – European public investment financing strategy would therefore have the potential to crowd in private investment and increase aggregate demand , with long – term positive effects on growth and employment .
The first is an expansion of lending by the EIB , based on an increase in its paid – in capital provided by EU members . The EIB’s ability to leverage its own financing to attract private co – investment enables a significant economic impact to be achieved from fairly limited public resources . Using the proven EIB would enable the programme to be implemented quickly and effectively .
Second , we propose that funds from the EU budget are used to mitigate investment risk for the private sector . Today many institutional investors such as pension funds and insurance companies do not fund large investment projects , particularly in infrastructure , due to a perception that the risks are too high .
Third, we suggest the creation of a new European Fund for Investment ( EFI )