Whither Capitalism (the Market Society)?
― The Manifesto of the Turning Point
Toshiaki Hirai (Sophia University
1. Introduction
The meltdown of the U.S.
At the same time, this is a state of affairs that marks a great turning point in the era. For “Neo-Liberalism” (=Market Fundamentalism) and the “New Classical School”, which have been predominant over these three decades in social philosophy and economics/economic policy, have collapsed, and governments all over the world are making great efforts to surmount the crisis based on new social philosophy and economics/economic policy.
In the present paper we will see where market society is moving, critically
examining the social philosophy, economic theory/policy in this tempestuous period. The underlying keyword should be the “turning point manifesto”, meaning by this the appearance of the modern version of the Keynes-Beveridge System (to the effect that if left to itself, the capitalistic system would bring about much unemployment and insufficient social security: hence the onus on the government to secure full employment and sufficient social security).
2. Turning Point of the Present World
― Current Situation and Economic Policy
Current Situation － At present the meltdown of the bubbled economy ignited by the collapse of sub-prime loans is driving American mega banks and investment banks to the brink of bankruptcy. And since sub-prime loans were aimed at millions of low-income earners, the meltdown of the finance bubble has cut the ground away from under their feet through foreclosure and the breakdown of home equity loans and credit card loans, resulting in the great slump in consumption (the symbolic scene is the plight of the Big Three). Many firms declining into underperformance have carried out large-scale restructuring, resulting in millions of unemployed. Thus a phenomenon very similar to the Lost Decade of Japan – the collapse of the real estate bubble, the disruption of the financial system, and injections of huge amounts of public funds by the central bank – has appeared (though the recent onediffers from the Lost Decade of Japan in billions of multi-layered securitized papers and the global-scale economic crises ignited by the collapse of them).
Because the economic meltdown occurred in the US US securitized papers were held by big financial institutions throughout the world, and a sharp drop in US consumption has hit the countries which relied on exports to America.
In the case of China , heavily dependent on export to the US China
In the case of EU, the major countries have made injections of huge amounts of public funds or resorted to nationalization in the face of the danger of collapse of the financial system, while in the ex-East European bloc countries serious economic crises have occurred through the outflow of foreign capital (grimly reminiscent of the financial crisis in interwar Europe which led to WWII). Recently the Czech Republic has asked (rich) Germany
In the case of Japan
Economic Policy － The fragility of the US
The Bush Administration had implemented “band aid” (patchwork) measures in order to deal with these crises. But the scale of the crises became so large and serious that the administration eventually enacted the “Emergency Economic Stabilization Act of 2008” on October 3. Through this 250 billion dollars were injected into nine mega banks.
The Obama Administration, which took office in February 2009, put forward two economic policies worthy of note. One is explicit revival of large-scale public works, which had so far been sealed off, aiming at creating employment (and at keeping environments clean) and a tax cut targeting the middle- and low-income classes - the “American Recovery and Reinvestment Act of 2009”. The other is drastic reform of the social security system. These can be evidently described as a modern version of the Keynes-Beveridge System and the New Deal. What set all this moving was, above all, the advent of the Obama Administration with these policy commitments, Keynes and the New Deal having been in vogue in the mass media, just as the Thatcher Government and Reagan Administration saw Neo-Liberalism and Monetarism riding the tide thirty years ago.
A large-scale fiscal policy (together with a social security system) was, in fact, implemented earlier in China than in the USA China UK
In the UK
Contrastingly, the EU is faced with a big dilemma. With the birth of the Euro the steering of monetary policy has been delegated to the European Central Bank (ECB). In fiscal policy, the member states are required to maintain balanced budgets, which means that they are no longer free to implement discretionary fiscal policies. There are some differences in power within the EU, and the weaker members are showing some irritation.
The financial summit G20 held in London on April 2, 2009, however, achieved some success, for a fiscal policy was agreed upon to cope with this crisis (spending a total sum of 500 trillion dollars [around 50,000 trillion yen] by the end of 2010), to strengthen the regulatory system for the stability of the financial system (in particular controlling hedge funds and tax havens), and to increase the IMF loan to the developing nations.
3. Turning Point in Social Philosophy
In social philosophy fundamental problems of the market society (=capitalism) are being addressed: how it should be evaluated; based on what theory or ground it should be evaluated; and how it should be reformed based on the evaluations. Social philosophy extends exploration to the intrinsic nature of market society, making value judgments on it, and considering the appropriate behavior. It should be, as Schumpeter put it, “vision”, and in the works of Keynes it is elucidated in the last chapter of the General Theory.
3.1 The Collapse of Neo-Liberalism (Market Fundamentalism)
It was the activities of the Monetarists, with Milton Friedman as their guru, that contributed to the spread of Neo-Liberalism, which can be seen as a counterrevolution against both Keynesian economics and the Keynes-Beveridge system. Monetarism delivered a great blow to them by putting forward, on the one hand, a new version of the quantity theory of money and the Natural Rate of Unemployment Hypothesis, and, on the other hand, by advocating Neo-Liberalism such as expounded in, for example, Free to Choose. The movement gathered momentum thanks to political support from the Thatcher Government (UK) and the Reagan Administration (US) in the1980s (On this occasion, Mises and Hayek – the Austrian School - were resurrected from long oblivion). There sprang from the stream of Monetarism a group of young economists who shared Neo-Liberalism and an economic policy stance (but differed in economic theory), namely the New Classical School lan d and Pres cott. It is a group engaged in theoretical and empirical study, believing in the price equilibrating mechanism of the market, Pareto optimality, and assuming the “(ultra-)rationality” of economic agents (Rational Expectation Hypothesis). It attracted much attention, claiming superiority for its theoretical models as well as empirical performance, and arguing against Keynesian theory and empirical study. It added the authority of economics to Neo-Liberalism, advocating trust in the market system.
What Happened － It has been argued fervently that the market society must be a system of self-discipline: one should confront the future with self-discipline in mind; success or failure should be attributable to one’s own responsibility; the government should not interfere with the market economy – such are the credo and motto of the Neo-Liberals.
What has happened in reality? Almost all the American mega-banks and investment banks have pleaded with the government for bailout. They had taken pride in making portfolio selection on the basis of financial engineering (multi-layered securitized papers were issued based on this technique). However, as soon as their banks were on the brink of collapse, their presidents hurried to the government, asking for huge amounts of public funds (and yet, despite these fatal blunders the top management has seldom been fired).
One of the causes of this messy state of affairs is ascribable to the fact that the realization of a “pure market society” has been advocated to an excessive degree without taking other things into consideration. Excessive liberalization has made too short-term speculative activities unruly, bringing about an atmosphere of neglect for social ethics by many managerial staff and, on the part of the public, dreams of get-rich-quick schemes. The consequence of these behaviors was abandonment of the “Principle of Self-Discipline” and the pleading with the government for bailout. (The scandal has shaken American society over the behavior of the AIG managerial staff, who received huge sums of public funds to award themselves lavish bonuses. They justify this behavior on the ground of “redemption of contract”. Here we see the collapse of business ethics).
The financial crises that have quite often hit the world economy in recent years and, above all, the present economic crisis that erupted with the collapse of the sub-prime system have exposed the fragility of Neo-Liberalism to the eyes of the public. So far short-run capital operations had been excessively liberalized, and multi-layered securitized papers hosannaed and issued ever more promptly as proving the excellence of financial engineering. Then, suddenly, mega financial institutions all over the world went bankrupt. They asked the governments for financial help, and the governments responded by injecting huge amounts of public funds, setting as top priority stabilization of the financial system. By contrast, many people have been unable to repay their mortgage loans and faced foreclosure, with much debt being left. The point to stress here is that they alone have been required to observe the “principle of self-discipline”.
It is worth noting that Neo-Liberalism has involved serious self-contradictory failures – the phenomenon of market non-existence and the phenomenon of market opaqueness.
The Phenomenon of Market Non-Existence － The fundamental problem with securitized papers lies in neglecting the market mechanism per se, betraying the slogan, “Leave everything to the market”. Many multi-layered securitized papers have had no market for pricing from the outset. In the case of collateralized debt obligation (CDO) as representative of securitized papers, for example, the current price has been determined by either a theoretical value according to a pricing model or a reference price proposed by the investment banks. Securitized papers, which have been hailed as top runners of the market economy and crystal of financial engineering, have had no market, and therefore no market mechanism whatsoever.
While the economy was going well (and finance theory was consequently believed to be trustworthy), nobody doubted the value of securitized papers. Once the meltdown occurred, however, the problem of market non-existence abruptly rose to the surface (because there existed no market, securitized papers are doomed to be wastepaper with no price). “American Financial Accounting Standard Committee No.157” lays down an “evaluation of fair value”, distinguishing three levels. Of these, Level 2 is an “evaluation based on the prices of similar papers transacted in markets” while Level 3 is an “evaluation based on a theoretical model, for there exists no price transacted”. The “Bad Bank Plan”, (the Geithner Plan) which the US Administration is about to carry out aims at the normalization of the financial market with both the government and private investors buying up the toxic assets (securitized papers) held by financial institutions. Whatever method might adopt, however, the administration can find no reasonable price for already damaged securitized papers.
The Phenomenon of Market Opaqueness ― Unlike the market for manufacturing and service industries, the financial market has gone through a dramatic transformation over these two decades due to deregulation and application of financial engineering. Heretofore the financing of firms had been procured through bank borrowing, equity and bonds (and this type of financing had been under surveillance by the regulatory agency). Because of the invention and development of securitized papers, however, financing methods have seen surprisingly rapid extension in recent years. As a result, the financial market has become ever more diversified and complicated, and supervision by the regulatory agency therefore increasingly difficult. This phenomenon or tendency has been applauded as demonstrating the victory of globalization, deregulation and the market over the state.
And yet this in itself became a major cause of the present crisis of the world economy. A huge amount of money has flowed into the buying and selling of multi-layered securitized papers, operated by financial institution beyond the reach of any supervision (such as hedge funds and structured investment vehicles – SIVs). They show no “transparency” at all, and have been free from any regulation or supervision. Any information to do with accounting, investment operations and so forth has been hidden behind the scenes. These institutions characterized by opacity have grown at an amazing speed, collected huge amount of funds from unknown investors and entered into speculative operations (accompanying leverage). As a result, they have brought about sudden and violent fluctuations in the financial markets throughout the world. No governmental agency has been able to keep these behaviors in check. All that could be done was symptomatic treatment (band-aid measures).
That is not the end of the story. Even the mega deposit banks under FRB supervision earnestly have been promoting and selling securitized papers. Escaping from the supervision of the regulatory agencies, they have accelerated the advancing opaqueness, off-balancing themselves with hedge funds, SIVs and so forth. Although the same period saw much talk of “information disclosure” and/or “accountability”, the reverse tendency has gone its way.
3.2 The Nature of the Market Society
What are the characteristic features of the market society? Let us mention several noteworthy points missing from Neo-Liberalism.
The Path of the Market Society ― It is very important to bear in mind the path along which the market society has proceeded, where all sorts of things are transacted as goods, even labor (and land) included. World history from the end of the 18th century to the present day might be characterized as the process of other countries’ endeavors to following the United Kingdom
The widening and deepening of the market released the energies pouring out of a “devil’s millstone”. However, it would be an exaggeration to say that the people did nothing to change the course of events, letting things go their way. In the UK
In order succ
The Nature of the Market Society ― What characterizes the market society is, above all, is its dynamism. It is dynamic in two senses. On the one hand, through the development of the division of labor and competition, and the technical innovation induced by them, the market society brings about economic growth. On the other hand, the widening and deepening of the market eat away and destroy the traditional system and institutions with formidable power (unchained Prometheus).
As the market society has these two features, it has an inherent potential instability. There still remains the formidable task for any nation setting out to be a successful market society of how to keep this “Prometheus” under control. The task seems to have been accomplished, for example, in present-day China
The Two-Tier System ― Entrepreneurs are required to sail out into new undertakings, which are finally tested and evaluated by the market. The fact is likely to be overlooked, however, that the actual market society is a two-tier system composed of big firms (listed companies) and small and medium-sized firms (non-listed companies).
In small and medium-sized firms the position of the top
We have quite often heard that “the capitalistic society is a system based on the principle of self-discipline”, meaning that the consequences, whether good or bad, of their own decision-making must be borne by the top management themselves. However, oberving business organization as comprising the fundamentals of the market society, it is not so much the top managers of big firms as those of small and medium-sized firms who respect (or are forced to respect) this motto.
The Emergence of Non-human Labor ― It is well known that the position of laborers has strikingly deteriorated over the past decade. According to the data of the Ministry of Internal Affairs and Communications, the number of non-regular laborers increased from 12.25 million in 1999 to 17.60 million in 2008, as a result of which the ratio of regular workers /non-regula r workers decreased from 75 to 66 percent.
Emblematic of the worsened situation of laborers is the Worker Dispatching Undertakings Act (revised in 1999), which enabled to dispatch workers to almost all businesses (1.4 million belonging to this category in 2008). This act, with the high-sounding name of “deregulation of the labor market”, has driven many laborers to conditions similar to those of the one-time proletariat who were not eligible for social security. Exploiting the euphuism of efficiency, the Japanese economy ― a highly developed market society ― has reintroduced inhuman working conditions with many people (top management included) endorsing and even applauding this act. We should be ashamed of this when we recall how our predecessors made such great efforts to create the welfare system.
The Similarity between Big Firms and Bureaucracy – It must be recognised that the difference between the big firms and the bureaucracy, apart from the difference in the principle of action [pursuit of private profit and that of the public good], is surprisingly small.
Until managerial leadership is settled severe competition is fought within a firm. Once somebody obtains leadership, he or she comes to enjoy the authority to decide on important strategies. Truly, entrepreneurial activities resemble the those of an adventurer whose ship sails out for the unknown world. Managers of big firms, however, are seldom required to take on responsibility even if they make serious mistakes. It is the employees who are forced to bear the burden of the mistake, losing their livelihood through restructuring.
The bureaucracy has a similar system to big firms in terms of hierarchy and career success. Again, before the bureaucratic leadership is settled there is fierce competition within the institution. Once somebody goes up to the top position, he or she comes to have the authority to decide on important policy formation. And again, policy activities are like the activities of an adventurer in the sense that they steer society towards the uncertain future. The top bureaucrats, however, are seldom required to take on responsibility even if they serious mistakes. It is the public who are forced to take on the burden of the blunder, bearing various kinds of liabilities.
I have drawn a comparison between big firms and bureaucracy since it is not so much the big firms in themselves as a combination of big firms and the bureaucracy which rules the roost in present market society. Neo-Liberalism, neglecting the real situation of the market society, has diffused the market society illusion – in the US and the UK, among other countries – that we can and indeed must reduce the role of the government to any degree.
Let us look at the actual world economy. China has, with political unification, attained great economic growth such as no nation had ever achieved before (now the economic growth rate which Japan had enjoyed in the 1960s looks modest in comparison). Russia has recently recovered, mainly through development of the natural resources, from the disorder of a decade ago, under the leadership of Putin (the so-called “Putin’s list” is a symbolic example). We also see the behaviors of the sovereign wealth funds (SWF) such as the Abdabi Developmental Investment Agency (ADIA) and the Chinese Investment Corporation (CIC) attracting great attention in the global economy.
Speaking of the present-day market society in the world perspective, we cannot ignore these phenomena. The issue of Capitalism vs. Socialism, which was a pivotal point in economic controversy, is no longer relevant. Rather, we have another problem – the definition of capitalism, for capitalism itself has been greatly transformed and diversified, in the of the present developments.
4. Turning Point in Economics
In the preceding section we saw the turning point in social philosophy. However, examining the present-day market society we must go further, for economic theory (and the economic policy based on it) has had some influence on the development of the market society. In this section, therefore, we consider how economic theory has evolved.
4.1 Looking Back Over These Three Decades
The “Neoclassical Synthesis” – the doctrine which has the “general equilibrium theory” at the level of microeconomics and Keynesian theory at the macroeconomic level (IS-LM theory. Also referred to as the “Income-Expenditure Approach”) – enjoyed its heyday until the end of the 1960s, but went on to decline in the 1970s. We might say that the thirty years thereafter saw bipolarization in economic theory and social philosophy. For the sake of convenience, let us examine this period, dividing it into two phases: (i) the internal disintegration of the Neoclassical school in the wider sense, and (ii) the rise of the anti-Neoclassical school.
Criticism of Keynesian theory was initiated by the Monetarists led by Friedman. Heated controversy raged over the Philipps Curve and the Natural Rate of Unemployment Hypothesis between the Keynesian School and Monetarism. Moreover, Keynesian theory came under heavier fire from the New Classical School, which is closely related to but does not follow Monetarismin theory.
The New Classical School has two strands. One is a (monetary) equilibrium theory of business cycle as represented by Lucas while the other is a real business cycle (RBC) theory as represented by Kydland and Prescott. Although the difference between the two lies, as the names indicate, in whether the true cause of business fluctuations is random fluctuations in money stock or to random fluctuations in real variables, the following points are shared in common.
The New Classical School starts out from the hypothesis that an individual has the ability to form “rational expectations” (“rational” is defined here with a specific implication). It also takes for granted that an individual has the ability to collect and analyze full information on the macro economy. The “rational expectations” per se are a technical assumption of expectations. As, however, they were used in the arena of economic policy, they were to have some influence in the real world. The New Classical School, moreover, places absolute trust in the equilibrating function of the price mechanism in the market economy.
As social philosophy the New Classical School advocates Neo-Liberalism, vehemently criticizing discretionary economic policy. It also criticizes – the so-called “Lucas critique” – forecasting based on the method of econometrics which developed hand in hand with Keynesian economics.
The theory of the New Classical School – which takes for granted full employment, Say’s law, Pareto optimality, a theory of (expected) utility, “extra” rationality of economic agents and the laissez-faire credo – has come to dominate economic theory and policy in these three decades. This phenomenon appeared for the first time since the birth of the Neoclassical School in the third quarter of the 19th century. This might be said to be a replacement of the Keynesian economics with the New Classical economics in the macroeconomic portion of the Neoclassical Synthesis.
It was the New Keynesian School which stood against these movements. The adherents of this school pay particular attention to the imperfection of the price mechanism in the market economy, pursuing the cause of various kinds of price inflexibility. They designate themselves as New Keynesians, for they claim that the most essential feature of Keynesian economics lies in identifying these price inflexibilities. In social philosophy they support discretionary economic policy, and succeed the old Keynesians (as will be seen below, however, they borrow their main theoretical tools from the New Classical School).
Another cause for the collapse of the Neoclassical Synthesis can be found in the activities of economists who stood outside it. The disequilibrium economics as represented by Clower and Leijonhufvud, and the Post Keynesian School as represented by Davidson and Mynsky are typical examples. Both are sympathetic to Keynes’s own theory and recognize the present relevance of the “original Keynes”, albeit on different grounds. Criticizing both Keynesian economics and the Walrasian general equilibrium theory, they tried to build their own theories based on what they believed to be essential in Keynes’s own theory. Thus both are either doubtful or critical of the assumption of full employment, Say’s law, the Pareto optimality, utility theory and the “ultra” rationality of economic agents.
4.2 The Collapse of the “New Classical School”
The New Classical School has claimed, taking for granted the “ultra” rationality of economic agents and placing absolute trust in the equilibrating mechanism of the market, that it can construct a theoretically rigorous model and scientifically explain the actual business cycles based on it (the so-called “Economic Policy Ineffectiveness Proposition” is relevant to this context).
The New Classicals have insisted that theirs are rigorous models mathematically constructed on the basis of the behaviors of economic agents. In fact, however, their models are constructed based on the “macro” economic agent called the “representative household” which is, moreover, assumed to maximize the expected utility, over an infinite period, under rational expectations formation. Using these models, they try to measure the degree of fitness in relation to the actual economy by means of “calibration”.
The method adopted by the New Classicals pays no attention to the relevance to the actual economy in which the people cannot help behaving under the situation in which the future is uncertain. I would like to point out three problems with the New Classical School from a methodological point of view.
On the Rigorousness of Microfoundations – First let us see the claim that macroeconomics should be rigorously constructed, by means of a deductive method, from microfoundations.
To this end the New Classicals adopt the rational expectation hypothesis. This plays an important role in aggregation from the micro level to the macro level (here various kinds of stochastic variables are assumed to take normal distribution with given averages, and variances, the values of which an economic agent is assumed to know). The rational expectation hypothesis also plays a technically important role in ascertaining the dynamic system of the model.
The New Classicals assume and indeed believe that an individual has a utility function, by means of which an individual can determine his/her consumption. In fact, however, they claim their model is rigorous by complicating a utility function in a way far from the behavior of any actual economic agent.
For example, the following type of utility function is assumed from the start.
∞
Ut = max Et (Σj=0 βju (ct+j, lt+j)) 0<β<1
（where β, ct and lt are, respectively, discount factors, consumption and leisure. E is an expectational operator, and U is utility.）
The New Classicals claim that the above type function is more elaborate than, for example, the following, for it takes inter-temporal utilities into account.
U= f (c, l)
They share the view with the old Neoclassicals that the essence of the behaviors of consumers can be completely expressed in terms of the utility function. They believe, however, that it should be more rigorous, and this task can be accomplished by formalizing a utility function in the dynamic framework, and introducing more complicated variables (we should not forget that they assume the representative household, whose utility function has an indefinite period of time and cardinal utility).
On the Rationality of Economic Agents – The New Classicals claim that the model constructed with their method is rigorous, rational and theoretical, for it is deductively derived from rational assumptions.
This model is, however, derived from assuming an economic agent far from any existing in the real world. The economic agent is assumed to have the ability to make terribly complicated calculations. And yet, what the economic agent is assumed to aim at shows no difference, in essence, from the maximization of the traditional utility function. The more complicated formula does not reflect the complexity of the real human activities.
On the Empirical Sphere – The New Classicals then assemble the macro data corresponding to their theoretical model (this belongs to the empirical sphere). The question addressed here is whether the result obtained is of statistical significance or not. How can the macro model, however, derived from the unrealistic maximizing behavior of a micro economic agent (the “representative household”) have any significance in examining the actual American economy?
So what can we expect the New Classicals to do now? Are they going to explain the critical situation of the present-day world economy with the same theory and method? Or are they assuming that the present situation is quite abnormal and no more than temporary, and that soon the economy will return to normalcy? Whichever they might choose, what is certain is the fact that neither their theory nor method are adopted in economic prognosis and economic policy in any country of the world. The New Classical School is in a state of collapse under the critical conditions of the world economy.
4.3 New Keynesians
The New Keynesians have some influence on the economic policy of the Obama Administration. After describing the features of this school, let us see how we should evaluate it in relation to the present economic crisis.
The New Keynesians, again, take the stance of emphasizing the imperfection of the price mechanism in the market economy, and argue that because of various kinds of price inflexibility there arises a deficiency in (aggregate) effective demand, and (involuntary) unemployment. They seek to explain why these price inflexibilities occur from a microfoundations point of view, putting forward various hypotheses (the “Menu Cost” hypothesis for price inflexibility, the “Efficiency Wage” hypothesis for wage inflexibility, the hypothesis of upper inflexibility of interest rate, and so forth). New Keynesians share a skeptical view of the equilibrating power of the market, admit the existence of “involuntary unemployment”, and negate Say’s law and the classical dichotomy, so in these respects they are in sharp contrast with the New Classicals. In social philosophy they are in a position to approve discretionary economic policy. Thus the New Keynesians can be said to succeed the “(Old) Neoclassical Synthesis”, and their position is therefore often referred to as the “New Neoclassical Synthesis”.
It should be noted, however, that the New Keynesians share important points with the New Classicals, for the New Keynesians fundamentally adopt the tools developed by the New Classicals: (i) the rational expectations hypothesis; (ii) the representative agent; (iii) dynamic general equilibrium analysis (Stiglitz, who declares himself New Keynesian, is an exception. He emphasizes the behavior of the risk-averting firm in uncertain conditions, taking a critical view of the rational expectations hypothesis and the representative agent).
In recent years the New Keynesians have worked out a macroeconomic model which has become prevalent in academia as well as among the central bankers, and is regarded as representing the “New Neoclassical Synthesis”. This is named a “New IS-LM model” (or “IS-AS-MP model”), which is composed of the three equations.
The first equation is called an IS equation, and is formulated in such a way that the output gap depends on the expected real rate of interest and the expected output gap in the next period (a stochastic variable called “aggregate demand shock” is added). This equation, which is often referred to as the “aggregate demand function”, is derived from the maximization of the expected utility of the household over an indefinite period. In this equation the price is determined through the “Calvo pricing” (which means abandonment of a consumption function).
The second equation is called a “New Keynesian Phillips Curve”, which is formulated in such a way that the rate of inflation depends on the output gap and the expected rate of inflation (a stochastic variable called “aggregate supply shock” is added). This equation is sometimes called the “aggregate supply function”.
The third equation concerns determination of the rate of interest. This usually adopts the “Taylor Rule”, which states that the (short-term) rate of interest (the FF rate in the case of the US) is determined by the rate of inflation and the output gap (which means the exclusion of both the liquidity preference function and the quantity theory of money). This method is assumed to be adopted by the monetary authority.
The main model of the New Neoclassical Synthesis is the New IS-LM model described above. Although it is named after the IS-LM model of the (Old) Neoclassical Synthesis, as is evident from the above explanation this denomination is quite misleading.
Having seen what the New Keynesians are, how, then, are we to evaluate them?
First of all, it should be noted that the present crisis of the world economy is beyond the reach not only of the New Classicals but also of the New Keynesians: we have no economic theory which can explain and address the present crisis.
That said, there is some room, albeit not a great deal, for coping with this crisis more flexibly taking the side of the New Keynesians rather than that of the New Classicals, for, as we saw above, the New Keynesian stance not only admits involuntary unemployment, but also negates Say’s law and the “Economic Policy Ineffectiveness Proposition”. More importantly, the New Keynesians endorse Keynes’s and Keynesian social philosophy, characterized by pragmatic flexibility.
What is now attracting much attention is fiscal policy, which is, par excellence, Keynesian. A sharp fall in effective demand implies not so much the problem of optimal dynamic allocation over an indefinite period as the role of the government. All the governments in the world now realize that the interest rate policy (Taylor rule), inflation targeting and quantity moderation as a non-traditional method, hitherto regarded as the only effective measures, cannot suffice for the recovery of the world economy. Thus fiscal policy, which has been “sealed off”, has come to be emphasized, reference to the multiplier theory being made, for example, in Romer=Bernstein (2009).
The reason why many New Keynesians took part in the Obama Administration
lies in the fact that, relatively speaking, the New Keynesians might have a better chance of dealing with this crisis. More importantly, again, the social philosophy to meet the needs of the times could be found on the side of the New Keynesians.
The actual situations of the present economic crisis, however, have gone beyond the economic theory of the New Keynesians. We could rather say that a theory might be rearranged in such a way as justify the effectiveness of fiscal policy.
4.4 How Should Economic Theory Go?
We have made a brief survey of how macroeconomics has proceeded in these three decades, and in the light of our survey we can see the various tasks facing us from now on.
The New Classicals claim that a macro model can and must be deductively constructed from microeconomic behaviors, while the significance of the model in relation to the real economy is to be evaluated in terms of calibration. We have already pointed out serious flaws in this method, and there is no need to repeat them here. It should be added, however, that they seeking to justify the model which includes the non-reality of microeconomic behaviors and the doubtful empiricism at the macro level by appealing to a kind of logical positivism.
We can not trust the future of economic theory to the approach taken by the New Classicals. An economics which assumes and/or takes for granted the representative household, rational expectations, rigorous formalism, utilitarianism, full employment and Say’s law can not put forward policy prescriptions for the present economic crisis (on this point, the New Keynesians are not entirely free from criticism, either).
What we should aim at is a path following a different course from the above – a path taking into consideration the need: (i) to make the fundamental assumptions more realistic; (ii) not to identify the “pseudo-” rigorousness with “science”; (iii) not to excessively sanctify mathematics, which is a neutral tool, and to build up a theory which takes the ambiguity, the complexity of the real economy into consideration; (iv) to pay more attention to the flexibility which language should possess;(v) to pay more attention to institutions and history; (vi) not to overindulged in technicalities, although data analysis is important.
Regarding these points Keynes offers us some very important suggestions. His method is well balanced. He had all the knowledge necessary to be able to construct theory, and yet did not indulge in it. He always paid attention to uncertainty, human psychology, institutions and history. From his own philosophical and logical point of view, he criticized the econometric method developed by Tinbergen, and the method of mathematical economics which aims at mathematization for the sake of mathematics, declaring economics a “moral science”. And yet Keynes had a keen flair for observing the actual economy and emphasized the importance of statistics throughout his life. The conditions which he mentioned, in regard to Marshall, for an excellent economist should also be true of Keynes himself. Among today’s economists these qualifications are sadly lacking.
5. The Present Relevance of Keynes
5.1 The Resurgence of Keynes
As the world economic crisis went from bad to worse reference to Keynes showed widespread increase. Neo-Liberalists and the New Classicals advocated the laissez-faire principle that if more deregulation was implemented, and more left to the market, the market society could enjoy unprecedented prosperity. Then the meltdown hit the world economy. Heaps of securitized papers became nothing, followed massive foreclosures and unemployment. The world economy has plunged into an unprecedented crisis which has drawn attention back to Keynes, who advocated economic policies to surmount the Great Depression in the 1930s.
While hardly any of the economists were able to do anything for the Great Depression, Keynes deftly put forward his own economic theory and policy proposals. Now the same phenomenon is emerging again, for the insignificance of the established macroeconomics has been exposed in the face of the world economic crisis. (the boast of “elaboration” has fallen to the ground).
It is not so much to the New Keynesians as to Keynes that the world has turned. M. Woolf and J. Ackerman declared their abandonment of the Neo-Liberalism they had embraced. R. Shiller and G. Akerlof urged the necessity of implementing Keynesian economic policy. J. Galbraith and P. Krugman also emphasized that Keynesian fiscal policy should be an effective means to tackle the present economic crisis. In October 2008, the (UK) Chancellor of the Exchequer, Darling insisted on the necessity of fiscal policy, praising Keynes. The economic policy staffs of the Obama Administration and many economists who are supportive of it are New Keynesians. The document announced on January 9, 2009, “The Job Impact of the American Recovery and the Reinvestment Program”, in which the Keynesian way of thinking is reflected, was written by C. Romer, Chairperson of the CEA and became the backbone of President Obama’s economic policy (“Emergency Economic Stabilization Act”). And so on and so forth.
The fact that Keynes is explicitly referred to in the context of economic policies in the major countries of the world is indicative of the resurgence of Keynes, considering that over the past thirty years Keynes has been attacked and scorned under the dominance of Reaganomics and Thatcherism.
5.2 Who is Keynes?
The period in which Keynes was active saw efforts to reconstruct the Pax Britannica, jeopardized by the First World War and brought low, while the world was plunging into the Second World War, aggravating the disorder and disintegration. In order to surmount these challenging situations, Keynes continued to put forward new economic theories and economic policy proposals as well as proposing a new world order.
These are not all his achievements. As is well known, he was to have great influence on macroeconomics, economic policy and social philosophy with his magnum opus, The General Theory (usually called the “Keynesian Revolution”). I will here confine myself, however, to his activities as economist for the sake of space.
The General Theory － Keynes sees the market economy as possessing two contrasting potentialities8: stability, certainty and simplicity; instability, uncertainty and complexity.
Stability, Certainty and Simplicity - Keynes argues that the market economy is equipped with several built-in stabilizers, the conditions being that ((i) The marginal propensity to consume lies between zero and one; (ii) Moderate changes in the prospective yield of capital or in the rate of interest will not cause great changes in the rate of investment; (iii) When the level of employment changes, the change in money wages will be modest; (iv) Capital has the property that fluctuations tend of themselves to reverse), so that it has an inherent tendency to converge to equilibrium. It does not, however, reach an optimum (or full-employment) level, but rather stays at underemployment level. This is the normal state of the market economy if left to itself.
Based on this “optimistic” vision, he constructs a theoretical model in which the level of employment is determined where the aggregate demand function intersects the aggregate supply function, incorporating the multiplier theory. The model is constructed in a simple and straightforward way.
Instability, Uncertainty and Complexity - At the same time, Keynes repeatedly argues that the stability which the market economy tends to cannot set in unless some conditions are met; failing these, the market economy is doomed to instability. In this respect we are faced with a structure built on fragile foundations, reflected in the uncertainty and complexity to be observed in the market economy.
Keynes argues that the working of the market economy depends on various psychological and expectation factors: short-term expectations; long-term expectations (the marginal efficiency of capital [the precariousness of the foundations upon which prospective yields are estimated, and that of the “convention”] and the nature of the stock market [the danger of “speculation” overwhelming “enterprise”]); the liquidity preference, and user cost. He also refers to “the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism” (GT, p. 161).
The other element making the market economy unstable is its vulnerability to large changes in some exogenous variables. Keynes is concerned, above all, with any large changes in the quantity of money or in money-wages, for they can bring about great changes in expectations. This is why he counsels not a radical but a modest monetary policy. Furthermore, he repeatedly argues that the market economy works in a complex and interactive way. Thus he urges that some of the destabilizing factors be got rid of, e.g. by making the stock market less accessible, introducing governmental management of investment, and issuing “stamped money”.
In using his own model to analyze the economy, Keynes repeatedly warns us to remember that what is being contemplated is only a simplification of the real world, and that if the real world were to be depicted with greater veracity it could be done only through the use of an interactive-descriptive method going far beyond the powers of any mathematical technique.
In the General Theory Keynes proposes some economic policies. Firstly, he suggests lowering the rate of interest. In order to do so, an increase in money supply by means of monetary policy is required. Should the rate of interest be very slow in falling due to the peculiarity of money, an idea of “dated money” is proposed. If there is some limit to lowering the rate of interest, then implementation of public investment by the government is recommended.
In relation to the Great Depression, “The Theory of Effective Demand” read at the American Political Economy Club in 1934 is worth noting. There Keynes emphasizes, in order to restore the American economy, the need for an increase in government spending through deficit financing. It was from this point of view that Keynes wrote an open letter to President Roosevelt, published in the New York Times.
As is illustrated by his famous catch phrase, “In the long run, we are all dead”, Keynes took a short-run viewpoint. Therefore, thinking the pitfalls of the capitalistic economy to be curable, he was to develop his economic theory and theory of economic policy based on it.
Keynes was of the opinion that because the competitive market system is subject to instability, it is sometimes needs to be rescued by the governmental intervention. He cherished New Liberalism which (in sharp contrast with the present Neo Liberalism) aimed at transition from economic anarchy to the system, and, for the sake of social justice and social stability, entailed a conscious policy of controlling and directing economic powers, aspiring to combine economic efficiency, social justice and individual freedom.
6. Conclusion
What I would like to emphasize from the outset in this conclusion is the fact that
social philosophy, intuition and reality rather than economic theory have contributed to the current turning point. Shocking crisis has hit the economy. Faced with this reality, the “rigorous” model based on the assumption of an “ultra-” rational economic agent has lost face. The New Keynesians, despite borrowing many elements from the New Classicals, have embraced a different social philosophy, which seems to have moved the New Keynesians to a more pragmatic line.
The economic policy now enjoying a great revival is fiscal policy. Although it has been sealed off over a long period, it is being implemented, pressed by necessity, throughout the world.
In the case of Japan, consumption and investment have remained low, and exports are in a dire situation due to the collapse of consumption in the US. This sharp drop in effective demand can not be dealt with by means of monetary policy only. If the government cannot sit and wait, the only means left is fiscal policy. The realities are prompting this shift. Although the fiscal policy implemented by the Chinese government may not consciously look to Keynes it is, in fact, faithfully following his prescription.
Thus it is certain that the “elaborate” economic model cannot get the world moving. Here again, social philosophy has more significance than economic theory. In mainstream economics, however, economists have paid little attention to this point, for they have the tendency to eschew social philosophical investigation. As is shown in the last chapter of the General Theory, however, the role played by social philosophy has had a very important part. Now we are acutely conscious of it.
The critical situation of the present world economy is very often compared to the Great Depression. True enough, it resembles the Great Depression in the sense that it started in the US, and dispersed throughout the world, wreaking havoc on the world economy.
However, there is a point of difference. The dominant social philosophy was not so much Neo-Liberalism as New Liberalism. The latter found the shortcomings of the market system in the growing disparity between rich and poor and a moral code deeply rooted in money making, and aimed at correcting these defects. The mainstream economics at that time differed from the current New Classicals, being keenly aware of the importance of discretionary economic policy implemented by the government in correcting these defects.
The current economic crisis is the consequence which the unregulated issue of multi-layered securitized papers and related moral hazard of many financial institutions have brought about, with the support of Neo-Liberalism and the New Classicals. Ironically enough, however, we have witnessed the phenomena of market non-existence and market opaqueness.
In what direction will the market society move henceforward? What is clear at the moment is the collapse of Neo-Liberalism, and the movement of the market society in a very different direction. In order to prevent the phenomena of market non-existence and market opaqueness which the excesses of Neo-Liberalism have brought about from re-occurring, many governments are moving to improve the system in such a way that they can control and oversee the financial market. The “Bad Bank Plan” announced by the US Treasury on March 23, 2009 (the “Geithner Plan”) is a symbolic example. Positive fiscal policy is also planned and implemented by many governments, including those of the US, the UK and China.
In the US, the “Emergency Economic Stabilization Act”, with the total sum of 787 billion dollars, was enacted on February 17, 2009. President Obama is setting priority on increasing employment through public spending on environmental infrastructure. He also tried to persuade the G20 countries to implement fiscal policy at the level of 2 percent of GDP (although here he did not succeed).
Another important problem concerns the behavior of firms. In these crises many big firms representing the market society (not only financial institutions but also manufacturing firms) have shown immorality. They had advocated the following principle: we must make decisions for the future with the “principle of self discipline” in mind; if firms failed in this enterprise they should disappear due to the market mechanism, through which the market society can attain efficiency, freedom, justice and growth. However, we are now witnessing that many business leaders who had been advocating the “principle of self discipline” were the first to plead with the government for financial help, bearing the principle of “too big to fail” in mind. Amazingly enough, moreover, having got huge bailouts, they are displaying shameless behavior in awarding themselves big bonuses, as is seen in the case of AIG. The fact that this kind of injustice, corruption and selfishness has been prevalent in the US business community is eloquent evidence that we need a new business model for the future of the market society. If a new type of business model were not created, the market society would face a bigger problem in the not-too-distant future (In the Financial Times, March 13, 2009, self-repentance of the Anglo-Saxon type managerial system by American managers are taken up).
The world is facing the turning point.
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＊＊＊ Addendum ＊＊＊
Ｉ．How Will the World Economy Go?
At the present moment it is China which is the only country which, recovering from the damage done by the Lehman Shock, is expected to attain 8 % rate of economic growth, while the USA, the EU and Japan are still situated in difficult conditions.
The USA and the EU were able to escape from the worst scenario - the meltdown of the financial system, due to huge amount of public money by governments (as far as this problem is concerned, Japan had no problem from the start). In the case of the USA, the financial system, inclusive of the stock market, has been stabilized. However, this is only true of the Wall Street, while many local banks have been struggling to escape from bankruptcy.
In the USA, the EU and Japan, what matters at present is the slackness of the Main Street, which is due to insufficient effective demand. Demand is composed of “Investment + Consumption + Government Spending + (Exports – Imports). In the three nations, lack in effective demand is clear-cut. Although the governments have implemented large-scale fiscal policy plus easy money policy (zero-rate of interest and quantitative easing), they have not been successful in dealing with the problem of insufficient effective demand.
In the midst of high unemployment, the public are distinctly inclined to decrease consumption (Saving Paradox. The appearance of the Calm Bees’ Society in terms of Mandeville). Even that level of consumption is sustained by a policy of ecocar tax cut and subsidies. In spite of ultra-easy money policy, we cannot see any conspicuous effect on the Main Street. Ineffectiveness or weakness of monetary policy in the phase of depression in the advanced economies are clearly seen. We should call this phenomenon “Avoidance of Use of Money” rather than “Liquidity Trap”.
In this respect, Japan might be in the worst situation. Japanese firms are eager to sell their products in the Chinese markets in order to recover their sales. They keenly recognize that the problem cannot be solved by means of exporting their products, for the quality of products in China has been amazingly improved. Thus we are now seeing a surge of direct investment in China, including automobile companies, electronic companies as well as supermarkets and food chain shops such as Yoshinoya. These phenomena are symbolized by the shock shown by the executives of Nissan Motors and Kubota who visited Chinese firms, which was featured in the reportage of NHK.
II. The Worrying Present Situation of the US Economy
At the present moment we need to pay attention to the following facts:
(1) The mega banks escaped from bankruptcy by getting huge amount of public money.
(2) The mega banks have made unparalleled profits through the dollar carry trade using the zero rate of interest.
That is, in spite of the repeated declaration of the necessity of regulating the mega banks under some authority since the Lehman Shock, almost no regulation has been made at all. The Financial Regulation Reform Act eventually was passed by the House last December, but it is still argued at the Senate. The mega banks, which were bailed out by the public fund, has made huge profits through zero rate of interest, and have distributed huge sum of bonus to the staff. Although this way of distribution has caused the public anger as well as the Obama Administration, the mega banks have paid little attention to them and gone their way. No policy has been implemented to abolish the Shadow Banking System as yet.
The Wall Street has shown no interest in making the Main Street recover itself. The FRB contributed to bail out only the mega banks, which means that the FRB and the mega banks are on the same boat. Big powers are concentrated in the FRB, and we see very strong adhesion in personal terms among the FRB, the mega banks and the Treasury Department.
The US Society has a potential risk that the two Americas – the mega banks and the public – are to be involved in a serious battle, which leads up to the more fundamental problem – What sort of Capitalism the world should aim at from now on?
Concerning the financial issues, we need to pay attention to the following
(1) How should the deliberation of the Financial Regulation Reform Act at the
Senate proceed? How can Senator Dodd, chairman of the Banking Committee, who recently declared his resignation, preside the Senate under the formidable situation in which the number of the Senators for the Democratic Party has become 59 rather than 60?
(2) How will the new tax named the Financial Crisis Responsibility Tax go? This is considered to appear from some consideration that the deliberations for the Financial Regulatory Reform Act has been too slow.
(3) How will the Obama Administration go as well as the US economy?
“Volcker Rule” was announced by Obama January 21, which is tougher than the Financial Reform Act under deliberation at the Senate. This indicates tougher stance against the mega-bank as well as a shift from Geithner to Volcker in the Administration.
