UCL ECON1005. THE WORLD ECONOMY. Hugh Goodacre. 8. FROM POST-WAR KEYNESIANISM TO WASHINGTON CONSENSUS.

1. UCL ECON1005. THE WORLD ECONOMY. Hugh Goodacre. 8. FROM POST-WAR KEYNESIANISM TO 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.

2. Post-war period: the orthodoxy changes • 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.

3. 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!

4. 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)

5. Great Depression: winter 1932-3, unemployment 3 million / over 22% Two traumatic periods for the UK macroeconomy Early 90s recession ‘NICE’ Early 80s recession Post-war boom 1945-early70s WW1 1914-18 WW2 1939-45 Consensus macro? Regular cycles 1936: publication of GT Unemployment in the UK, 1880-2005. Stagflation 1970s Classical revival Post-war Keynesianism Note 3 successive dominant currents in post-war macro

6. 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.

7. UK unemployment and inflation: inverse relationship, 1919 - 38 Unemployment Inflation % Unemployment % of workforce Inflation Unemployment and inflation go in opposite directions during this period. They show an ‘inverse relationship Negative inflation is termed deflation

8. The Phillips Curve

9. 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.

10. (b) Developing countries. Consensus favourable: • Sustaining global demand • IMF: Deficit financing (on a global scale). • Opposite of its role later!

11. 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.

12. 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.

13. ‘Prebisch-Singer Hypothesis’: e.g. Real agricultural raw material prices, 1968-2002

14. Percentage of trade within own region, 2002:

15. Pressure for a New International Economic Order. • 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.

17. 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).

18. 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.

19. ‘Stagflation’: Breakdown of the stable Phillips Curve. From late 1960s, negative relationship between u and π no longer evident

20. 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!

21. 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.

22. 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)

23. 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.

24. 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

25. 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? AS 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↑. P4 P3 AD4 P2 AD3 AD2 Keynes and classical economics P P1 AD1 YFE YR Y

26. Classical counterattack: arguments for shift to LR perspective: Small difference in growth rate can have massive effect in LR:

27. 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.

28. Classical revival / ‘supply-side economics’ /counter-attack against post-war Keynesianism:the issue of long-run growth. Actual output National output (Y) Trend growth Fluctuates with the course of the business cycle -- upturn, expansion, peaking-out, slowdown / recession. Time

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

30. 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.

31. 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).