Whither Capitalism (Market
Society)?
―A Manifesto of the
Turning Point
Toshiaki Hirai
1. Introduction
The
meltdown of the U.S. financial system is driving almost all the nations of the
world into critical conditions. Many financial institutions as well as
manufacturing firms have gone bankrupt, which has sent the numbers of unemployed
soaring throughout the world. Various governments have made strenuous efforts
to surmount the crisis, injecting huge amounts of public money to stabilize
their monetary systems, and implementing drastic fiscal policies to cope with
massive unemployment.
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
social philosophy and economic theory/policy in this tempestuous period. The
underlying keyword should be the “manifesto of the turning point”, meaning by
this the appearance of the modern version of the Keynes-Beveridge System (to
the effect that if it is 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 from under their feet through foreclosure and the collapse of
home equity loans and credit card loans, resulting in agreat 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 the 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 emerged, differing in the issue of billions of multi-layered
securitized papers and global-scale economic crises.
Because the economic
meltdown occurred in the US which acts as the center of the world economy, the
impact has spread throughout the world: A vast quantity of 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 the
US.
In the case of China,
heavily dependent on export to the US, the huge drop in US consumption has
caused a sharp fall in exports, which led to unemployment for 20 million migrant
workers (nongmin gong). So China is
proving a real tinderbox in that, if it fails in implementing an appropriate
economic policy, dire social and political turmoil might ensue.
In the case of the EU, the
major countries have made injections of huge amounts of public funds and resorted
to nationalization of mega banks in the face of the collapse of the financial
system, while in the ex-East European countries serious economic crises have
occurred through the outflow of foreign capital (this is grimly reminiscent of
the financial crisis in interwar Europe which led to WWII). [LG1] The Czech Republic
has asked (rich) Germany
In the case of Japan,
many leading industries, including automobiles and electric goods, have met with
massive loss at every door due to a sharp drop in exports. For the sake of
survival they have implemented drastic restructuring, which has resulted in a
sharp drop in consumption and investment. The depression spiral has thus proved
very serious.
Economic
Policy
－ The fragility of the US financial system was
already apparent in the summer of 2007. In October the Citi Group, Merrill
Lynch and so forth announced huge losses related to sub-prime loans. March 2008
saw the Bear Sterns crisis, followed by the Fannie Mae and Freddie Mac crises
in July. Then, in September, a large-scale meltdown occurred.
The Bush Administration
continued to implement “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 pushed through Congress the “Emergency Economic
Stabilization Act of 2008” on October 3, through which 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
the environment clean) and a tax cut targeting the middle- and low-income
classes the “American Recovery and Reinvestment Act of 2009”. The other was a
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 saw
the revival of Keynes and the New Deal in the mass media was, above all, the advent
of the Obama Administration with these policy commitments (just as the Thatcher
Government and the Reagan Administration brought about the tide of
Neo-Liberalism and Monetarism 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. Through the “Reform and Opening” Policy
ignited by Deng Xiaoping’s “Let-Some-People-Get-Rich-First” Campaign, China has
continued to attain miraculous economic growth over long years, while social troubles
(such as the widening gap between rich and poor (entrepreneurs cum cadre men of
the Communist Party vs. farmers), environmental pollution[LG2], the absence of social
security, and the distortion of the balance of the genders as a result of the “One
Child Policy”) have become ever acuter. Then the great Tsunami hit China as
well. Thus a great change in steering the economy has become imperative. (In
the 11th National Assembly of the Peoples’ Representatives in March
2009, the total amount of 400 trillion yuan (about 5600 trillion yen) was
announced to be spent over the next two years for fiscal policy together with
50 trillion yuan (about 700 trillion yen) for tax cuts, while extension of
unemployment insurance as well as medical reform were proposed. In a word, in
order to redress the excessive “market economy phenomenon” a sort of
Keynes-Beveridge System is going to be introduced (which reminds us of the
situation in the UK of the early 20th century).
In the UK Prime
Minister Gordon Brown has urged the need to implement active fiscal policy,
which signals a transformation from the Neo-Liberalism espoused by the Thatcher
Government to Keynesian Social Philosophy.
Contrastingly, the EU
is faced with a big dilemma. With the birth of the Euro the steering of
monetary policy was 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, to
cope with this crisis, it agreed to spend a total sum of 500 trillion dollars
[around 50,000 trillion yen] by the end of 2010 (for fiscal policy), to
strengthen the regulatory system for the stability of the financial system (in
particular, to control hedge funds and tax havens), and to increase the IMF
loans to the developing nations.
3. Turning Point in Social Philosophy
In social philosophy the
fundamental problems of market society (capitalism) are being addressed: how should it be evaluated; based on what theory
or grounds should it be evaluated; and how should it be reformed based on thos
evaluations. Social philosophy extends our exploration to the intrinsic nature
of market society, makes value judgments on it, and considers the appropriate
behavior. It should be, as Schumpeter puts it, “vision”, and/or something like
what 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 promulgation 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
with the help of 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).
From the stream of Monetarism there sprang a
group of young economists who shared the Neo-Liberalism and economic policy
stance with Monetarism (but differed in economic theory) – namely the New
Classical School as represented by Lucas, Kydland and Prescott. It is a group engaged
in theoretical and empirical study, believing in the price equilibrating
mechanism of the market and the Pareto optimality, and assuming the “(ultra-)rationality”
of economic agents (Rational Expectations Hypothesis). Getting a lot of attention,
it claimed superiority both in theory as well as in substantive testing over the
Keynesian School. It gave Neo-Liberalism added academic prestige, advocating
trust in the market system.
What
Happened
－
It has been fervently maintained that market society must be a
system of self-responsibility: one should confront the future, keeping self-responsibility
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 Neo-Liberals.
What has happened in reality? In the
present meltdown almost all the American mega-banks and investment banks have solicited
the government for bailouts. They had taken pride in making portfolio selection
by financial engineering techniques (based on which multi-layered securitized
papers went on being issued). However, as soon as their banks were on the brink
of collapse, the presidents hurried to the government, asking for huge amounts
of public funds (and yet, they have seldom been fired for these blunders).
One of the causes of this messy state of
affairs is ascribable to the fact that the attainment of a “pure market
society” has been excessively advocated without paying attention to other
things. Excessive liberalization has caused unruly short-term speculative
activities, bringing about, on the side of the managerial staff, an atmosphere
of negligence of social ethics (and, on the side of the public, dreams of get-rich-quick
schemes). The consequence of these behaviors was abandonment of the “Principle
of Self-Responsibility” and the pleading with the government for bailout. (The
scandal has shaken American society over the behavior of the AIG managerial
staff, who, receiving huge sums of public funds, decided to award lavish bonus
to themselves. They justified this behavior by arguing for the “redemption of
contract”. Here we see the collapse of business ethics).
The financial crises which
have quite often hit the world economy in recent years and, above all, the
present one which has been ignited by the collapse of the sub-prime loan system
have exposed the fragility of Neo-Liberalism to the public. So far short-run
capital operations have been excessively liberalized, and multi-layered securitized
papers which have been structured and issued have been praised as proving the victory
of financial engineering. Then the meltdown suddenly occurred, and mega
financial institutions all over the world went bankrupt. They asked the
governments for financial help. The governments responded by injecting huge amounts
of public funds, stating that the stabilization of the financial system should
be set as top priority. By contrast, many people have been unable to repay
their mortgage loans and have faced foreclosure with much debt being still left.
The point to stress here is that it is these citizen only who have been asked
to observe the “principle of self-responsibility”.
It is worth noting that Neo-Liberalism has involved
serious self-contradiction – the phenomenon of market non-existence and that 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, 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 lack of a of market abruptly rose to the surface
(because there existed no market, securitized papers were doomed to be wastepaper
with no price). “American Financial Accounting Standard Committee No.157” lays
down an “evaluation of fair value”, distinguishing
three levels. 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 determined”. The “Bad Bank Plan”, (the
Geithner Plan) which the US Administration carried out aimed at the
normalization of the financial market through purchase, by both the government and private
investors, of the toxic assets (securitized papers) held by financial
institutions. Whatever method might be adopted, however, the administration can
find no reasonable price for heavily damaged securitized papers.
The
Phenomenon
of Market Opaqueness ―
In contrast to 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. Previously
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. As a result,
the financial market has become ever more diversified and complicated, and
supervision by the regulatory agency has become 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. A huge amount of money
has flowed into the buying and selling of multi-layered securitized papers, which
have been operated by financial institutions (such as hedge funds and structured
investment vehicles [SIVs]) beyond the reach of any supervision. 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 hidden investors
and have entered into speculative operations (simultaneously using leverage).
When their activities have brought about a sudden and violent meltdown in financial
markets throughout the world, therefore, no government agency has been able to stabilize
the markets. All that could be done was symptomatic treatment (band-aid
measures).
That
is not the whole story. Even the mega deposit banks under the supervision of FRB
have been earnestly promoting and selling securitized papers. Escaping from the
supervision of the regulatory agencies, they have accelerated the degree of opaqueness
by 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 hasalso been very strong.
3.2 The Nature of Market Society
What are the
characteristic features of market society? Let us mention several noteworthy points
escaping the attention of Neo-Liberalism.
The Path of Market Society ― It is very important to bear in mind the path
along which market society has proceeded, where all sorts of things, including
even labor (and land) are transacted as goods. World history from the end of the
18th century to the present day might be characterized as the process of other
countries’ endeavors to follow the United Kingdom, which had accomplished the
Industrial Revolution, in building their market societies. To increase
productivity dramatically, to widen and deepen markets through industrialization
and to use the fruits of economic growth thus obtained for military and welfare
purposes ― such were the goals doggedly pursued by these countries, which were eventually
to come to lead and rule the world. The
widening and deepening of market set free the energies from a “devil’s millstone”.[LG3]
However,
it would be an exaggeration to say that the people, letting things go their
way, did nothing to change the course of events. In the UK, for example,
society has gradually become “milder”, removing the baleful effects of the Industrial
Revolution with various kinds of safety nets. In fact, it was only in the third
quarter of the 19h century that laissez-faire was fully embraced. Since then some
version of collectivism and welfarism have held sway.
In
order to succeed in widening and deepening the market while mitigating social
unrest, it is indispensable to keep volcanic energies from a devil’s millstone under
control. A successful market society did not emerge by simply following the
laissez-faire principle. We have often seen how enforcement of the laissez-faire
principle without any alleviation has caused social/economic disorder and
confusion. The present meltdown is a typical example.
The Nature of the Market Society ― What characterizes contemporary
market society is, above all, 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, market society brings about economic growth.
On the other hand, the widening and deepening of the market eat away and
destroy the traditional system with the formidable power of an “unchained
Prometheus”.
Because
market society has these two features, it has an inherent instability built-in.
For any nation setting out to be a successful market society, there remains a
formidable task of how to keep “Prometheus” under control (this point of view escapes
the attention of Neo-Liberalism). It seems to have been accomplished, for
example, in present-day China.
Two-Tier System ― Entrepreneurs are required to sail out into new
undertakings, which are finally tested and evaluated by the market. It is often
overlooked, however, that market society is in fact a two-tier system ― big
firms (listed companies) and small/ medium-sized ones (non-listed companies).
In small/medium-sized firms the position of
the top management is quite different from that in big firms. They have the
right to make decisions, and must take on the responsibility. When they would
like to embark on new ventures, they need to get loans from a bank with their
own mortgages pledged as collateral. If they fail in the enterprise, the
mortgages are to be foreclosed, and the managers are to wander around the
street.
It is quite often said that “the capitalistic
society is a system based on the principle of self-responsibility”, meaning by
this that the consequences, whether good or bad, of decision-making must be
borne by the decision makers themselves. Among business organizations as
comprising the fundamentals of the market society, however, it is not so much
the top managers of big firms as those of small / medium-sized ones who comply (or
are forced to comply) with this principle.
The Emergence of Inhuman Labor ― It is well known that
the position of laborers has strikingly been 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 in 2008, as a result of which the
ratio of regular workers over non-regular workers decreased from 75 to 66
percent.
In
Japan, the “Worker Dispatching Undertakings Act” (revised in 1999) is emblematic
of the worsened situation of laborers, for it enabled workers to be dispatched
to almost all businesses (1.4 million belonged to this category in 2008). This
act, under the high-sounding name of “deregulation of the labor market”, has thrust
many laborers into conditions similar to those of the one-time proletariat who
were not eligible for social security. Under the euphuism of efficiency voiced
by the government and the top management, the Japanese economy ― a highly
developed market society ― has accepted inhuman working conditions. We should be
ashamed of this to our predecessors who made great efforts to create the welfare
society.
The Similarity between Big Firms and the Bureaucracy – It must be recognized 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 might be 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 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 mistakes,
losing their livelihood through restructuring.
The
bureaucracy has a similar system to big firms in terms of hierarchy and career
success. Again, until the bureaucratic leadership is settled, there is fierce
competition within an institution. Once somebody rises to the top position, he
or she comes to have the authority to decide on important policy issues. And
again, policy activities are like the activities of an adventurer in the sense
that they will steer the society towards the uncertain future. The top bureaucrats,
however, are seldom required to take on responsibility even if they make 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 the bureaucracy, for it is not so much the big
firms alone as a combination of big firms and the bureaucracy which rules the
roost in present market society. Neo-Liberalism, neglecting this real situation
of market society, has spread the illusion of the market society – in the US
and the UK, among others – that we can and must reduce the role of the
government to the minimum level.
Let us look at the
actual world economy. China has, with political unification,[LG4] attained great economic
growth to such a degree to which no nation had ever achieved (now the economic
growth rate which Japan had enjoyed in the 1960s looks modest in comparison).
Russia has recently recovered, mainly through development of natural resources,
from the disorder of a decade ago, under the leadership of Putin (the so-called
“Putin’s list” symbolizes it). We also see the sovereign wealth funds (SWFs)
such as the Abu DhabiDevelopmental Investment Agency (ADIA) and the Chinese
Investment Corporation (CIC), which are attracting great attention in the
global economy.
Viewing
present-day market society in a global perspective, we cannot ignore these
phenomena. The issue of Capitalism vs. Socialism, which was a great controversy
in economics, is no longer relevant. Rather, we have another problem – the definition
of capitalism, for capitalism itself has been greatly transformed and
diversified in the process of the present development.
4. Turning Point in
Economics
In
the preceding section we saw the turning point in social philosophy. However, in
order to examine present-day market society we need to go further to economic
theory, for it (and economic policy
based on it) has had some influence on the development of market society. In this
section, therefore, we will 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”)
as its core – enjoyed its heyday until the end of the 1960s, but went into 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 Phillips Curve and the Natural Rate of Unemployment
Hypothesis between the Keynesian School and Monetarism. Then, Keynesian theory came
under heavier fire from the New Classical School, which is closely related to,
but does not follow Monetarism in theory.
The New Classical School has two
strands. One is a (monetary) equilibrium theory of the 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,
as the names indicate, lies in whether the true cause of business fluctuations
is found in random fluctuations in money stock or those in real variables, the
following points are shared in common.
The New Classical School starts out from
the hypothesis that an individual has an ability to form “rational
expectations” (“rational” is defined here with a specific implication). It also
takes for granted that an individual has an ability to collect and analyze full
information about the macro economy. “Rational expectations” per se are a
technical assumption of expectations. As they were used in the arena of
economic policy, however, they were to have some influence in the real world.
Moreover the New Classical School places absolute trust in the equilibrating
function of the price mechanism in the market economy.
In
the field of social philosophy the New Classical School advocates
Neo-Liberalism, vehemently criticizing discretionary economic policy. It also
criticizes forecasting based on the method of econometrics, which developed
hand in hand with Keynesian economics – the so-called “Lucas critique”.
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 the scene of 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 Keynesian economics with the
New Classical economics in the macroeconomic portion of the Neoclassical
Synthesis.
The New
Keynesian School 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 inflexibilities. They
designate themselves as New Keynesians, for they insist that the most essential
feature of Keynesian economics lies in identifying these price inflexibilities.
In the field of social philosophy they support discretionary economic policy, and
are seen as successors to the old Keynesians (as will be seen below, however,
they borrow their main theoretical tools from the New Classical School).
Another cause of 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 representatives. 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 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 that it can
construct a theoretically rigorous model and explain scientifically the actual
business cycles based on it (the so-called “Economic Policy Ineffectiveness
Proposition” is relevant in this context).
The
New Classicals insisted that their models are rigorously and mathematically constructed
based on the behavior of economic agents. In fact, however, these models are
constructed based on the “macro” economic agent (the “representative household”),
which is, moreover, assumed to maximize the expected utility over an infinite
period under rational expectations formation. Using these models, they tried to
measure the degree of fitness in relation to the actual economy by means of problematic
“calibration”.
The
method adopted by the New Classicals pays no attention to the relevance ofthe
actual economy in which the people cannot help behaving under a uncertain situation.
I would like to point out three problems 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 believe that an individual has a (cardinal) utility
function, by means of which an individual can determine his/her consumption.
Moreover, they claim that their model is rigorous, formulating a utility
function in a complicated and disguised way.
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 sub="sub">
（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 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 behavior of
consumers can be completely expressed in terms of a utility function. They
believe, however, that it should be more rigorous, and that this task can be
accomplished by formalizing a utility function in a 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 is expressed in terms of cardinal utility).
On the Rationality of Economic Agents – The New Classicals
claim that the model constructed by 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 economic
one existing in the real world. The economic agent is assumed to have the
ability to make terribly complicated calculations. And yet, what he 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 and try to
examine the affinity of it to the actual economy by means of “calibration”. This
belongs to the empirical sphere. The question addressed here is whether the result obtained fits the actual economy or
not. However, the problem does not lie here but in the following: What
significance on earth can the macro model, which is derived from the
unrealistic maximizing behavior of a micro economic agent (the “representative
household”), have in studying the business fluctuations of the actual 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 by means of the same theory
and method? Or do they findi some
consolation by assuming that the present situation is quite abnormal and no
more than temporary, and that soon the economy will return to normalcy?
Whichever they choose, what is certain is the fact that neither their theory nor
method is 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 inflexibilities there arises a deficiency in (aggregate) effective
demand, and (involuntary) unemployment. They seek to explain why these price
inflexibilities occur from the point of view of microfoundations, 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). The New Keynesians share a skeptical
view of the equilibrating power of the price mechanism of the market economy,
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 the field of social philosophy they are in a position to
approve discretionary economic policy. Thus the New Keynesians can be said to be
the successors of 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 they 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 calls 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 popular in academia as well as among the central bankers. The model,
which is regarded as representing the “New Neoclassical Synthesis”, is named a “New
IS-LM model” (or “IS-AS-MP model”). It is composed of 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. Here the price is determined through the
“Calvo pricing” (which involves 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). It is sometimes called the
“aggregate supply function”.
The third equation concerns determination of
the rate of interest. It usually adopts a “Taylor Rule”, according to which 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 an exclusion of both
the liquidity preference function and the quantity theory of money). This method
is assumed to be adopted by the monetary authority. [LG5]
Although it is named after the IS-LM model of
the (Old) Neoclassical Synthesis, this denomination is quite misleading (as is
evident from the above explanation).
Having
seen what the New Keynesians are, how 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 on 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 as 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 that of the role
of the government. All the governments in the world now realize that interest
rate policy (Taylor rule), inflation targeting and quantity moderation as a non-traditional
method cannot be sufficient for the recovery of the economy. Thus fiscal policy,
which has been so far “sealed off”, has come to be emphasized, and reference to
the multiplier theory is 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, 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 Where Should Economic Theory
Go?
Now that we have made a brief survey of how
macroeconomics has proceeded in these three decades, we can see various tasks facing
us from now on.
The New Classicals claim that a macro model can
and must be deductively constructed from microeconomic behavior, while the
significance of the model in relation to the actual 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. It should be added, however, that
they seek to justify their “rigorous” model by appealing to a doubtful
empiricism at the macro level. This should be a distorted version of logical
positivism.
We cannot trust the future of economic theory to
the approach taken by the New Classicals. Economics, which 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).
What
we should aim at is a path following a different course from the above – a path
paying attention to the following points: (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 and the
complexity of the actual economy into consideration; (iv) to give more space to
the flexibility which language should possess;(v) to give more space to institutions
and history; (vi) not to be overindulged in technicalities, although data analysis
remains important.
Regarding
these points Keynes offers us very important suggestions. His method is well
balanced. He had all the knowledge necessary 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 [LG6] quantification for its
own sake, declaring that economics should be a “moral science”. At the same
time 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
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 has shown widespread increase. Neo-Liberalists and the New
Classicals advocated the laissez-faire principle that if more deregulation was
implemented, and more were 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 by 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 arrogant
pretension 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 (“American Recovery and Reinvestment 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, which was jeopardized by the First World War. But the period saw the
disorder and disintegration of the world aggravated, and led up to the Second
World War. In order to surmount these challenging situations, Keynes continued
to put forward new economic theories and economic policy proposals (as well as a
new world order plan).
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”).
In this book 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, which
run as follows: ((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. It has, therefore, an inherent tendency to
converge to equilibrium. This does not mean, however, that the market economy
will reach an optimum (or full-employment) level, but that it will rather stay
at underemployment level. This is the normal state of the market economy if it
is 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 built in a simple and straightforward way.
Instability,
Uncertainty and Complexity - At the same
time, Keynes repeatedly argues that the stability toward which the market
economy shows a tendency cannot be attained unless some conditions are met;
failing these, the market economy is doomed to be unstable. In this respect the
market economy is a structure built on fragile foundations that involve uncertainty
and complexity.
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 the nature of the stock market [the danger of speculative activities’ swallowing
“enterprise” activities]); 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 change in the quantity of money
or in money-wages, for they can cause large changes in expectations. This is
why he recommends not a radical but a modest monetary policy.
Furthermore, he time and again argues
that the market economy performs in a complex and interactive way. Thus he
urges that some destabilizing elements should beeliminated, e.g. by (i) making
the stock market less accessible, (ii) introducing governmental management of
investment, and (iii) issuing “stamped money”.
In using his own model, Keynes repeatedly
reminds us of bearing in mind that the model is no more than a simplification
of the actual world, and that if the actual world were to be depicted with
veracity it could be done only through an interactive-descriptive method, which
goes far beyond any mathematical technique.
In the General Theory Keynes proposes some
economic policies in order to conquer the Great Depression. 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, a “dated money” plan is put forward.
If there is some limit to lowering the rate of interest, then public investment
by the government is recommended.
In relation to the
Great Depression, the paper, “The Theory of Effective Demand”, which was read
at the American Political Economy Club in 1934, is worth noting. There, in
order to restore the American economy, Keynes emphasizes the need for an
increase in government spending through deficit financing. It was also from
this point of view that Keynes wrote an open letter to President Roosevelt, which
was 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 point of view. Assuming the pitfalls of the capitalistic economy to
be curable, therefore, he was to work out his economic theory and economic
policy based on it.
Keynes was of the opinion that because
the competitive market system is subject to instability, it sometimes needs to
be rescued by the governmental intervention. He cherished New Liberalism which,
in sharp contrast with the present Neo Liberalism, aims at transitioning from “the
Era of Abundance” to “the Period of Stabilization”. It advocates a conscious policy
of controlling/directing economic powers for the sake of the harmonious
combination of social justice and stability with economic efficiency and
individual freedom.
6. Conclusion
What
should be emphasized from the outset 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 seeing a great revival is fiscal policy. Although it has
been sealed off over a long period, it has been implemented, spreading 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 cannot be dealt with by means of monetary policy
only. If the government cannot sit and wait, the only remaining means is fiscal
policy. The realities are prompting this shift. Although the fiscal policy
implemented by the Chinese government might 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, economists have paid little attention to this point, for
they would be tempted to eschew socio-philosophical problems. As is shown in
the last chapter of the General Theory,
however, the role played by social philosophy has been great in transforming
not only market society but also society in general. Now we are acutely
conscious of it.
The
critical situation of the present world economy is quite often compared to the
Great Depression. True enough, it resembles the Great Depression in the sense
that it started in the US, and had repercussions throughout the world.
However,
there is a point of difference. The then dominant social philosophy was not so
much Neo-Liberalism as New Liberalism. The latter saw the shortcomings of the
market system in the growing disparity between rich and poor as well as in the
moral code deeply rooted in money making, and aimed at correcting them. The then
mainstream economics differed from the current New Classical Economics, being keenly
aware of the importance of discretionary economic policy in correcting these shortcomings.
The
current economic crisis is the consequence of the unregulated issue of multi-layered
securitized papers and the closely related moral hazard brought about by many
financial institutions with the support of Neo-Liberalism and the New Classical
Economics. Ironically enough, however, we have witnessed the phenomenon of
market non-existence and opaqueness.
In
what direction will 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 opaqueness, to which the excesses of Neo-Liberalism have
led, from re-occurring, many governments are moving to improve the financial
market in such a way as they can control and oversee it. The “Bad Bank Plan”,
which was announced by the US
Drastic
fiscal policy is also being planned and implemented by many governments,
including the US, the UK and China.
In
the US, the “American Recovery and Reinvestment 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 the environmental
infrastructure. He also tried to persuade the G20 countries to implement fiscal
policy at the level of 2 percent of GDP (although on this point he did not
succeed).
Another
important problem concerns the behavior of firms. In these crises many big
firms as the representatives of market society have exposed immorality. They had
advocated the following: we must make decisions toward the future, bearing the
“principle of self-responsibility” in mind; if firms failed in their enterprise,
they should disappear through the market mechanism, through which the market
society can attain efficiency and growth, and enjoy freedom. However, we are
now witnessing that many business leaders, who had been advocating this principle,
were the first to plead with the government for financial help, this time
bearing the principle of “too big to fail” in mind. Amazingly enough, moreover,
having got huge bailouts, they are beginning to display shameless behavior in
awarding themselves big bonuses, as is typically 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 an eloquent evidence for us needing a new business
model for the future of the market society. If it were not created, the market
society would face a more serious 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.
References
Akerlof, G. and
Shiller, R. [2009], Animal Spirits, Princeton University
American
Economic Review
[1997], “Is there a Core of Practical Macroeconomics That We Should All
Believe?”, May, pp. 230-246.
Bateman, B., Hirai, T.
and Marcuzzo, M. C. [2010], The Return to
Keynes, Harvard
University
Buiter, W.[2009], “The
Unfortunate Uselessness of Most ‘State of the Art’ Academic Monetary
Economics”, Economist’s View, March
3.
Buttonwood [2009], “The
Grand Illusion”, Economist Print Edition,
March 5.
Clarida, R., Gali, J.
and Gertler, M. [1999], “The Science of Monetary Policy: a New-Keynesian
Perspective” Journal of Economic
Literature 37, pp. 1661-707.
Collard, D., “IS-LM
Persistence” (in De Vroey and Hoover
Friedman, M. and R.
[1990], Free to Choose, Mariner
Books.
Greenwald B. and
Stiglitz J., [1993], “New and Old Keynesians”, Journal of Economic Perspectives, vol. 7, n° 1.
Henderson, B.E. and Geis, G., The Economic Tsunami, Saga,
2008.
Hirai, T. [2003], Looking
at Keynes’s Economics from Muliple Points of View, University of Tokyo
Press (in Japanese).
Hirai, T. [2007], Keynes’s
100 Words of Wisdom, Toyo Keizai Shinposha.
Hirai, T. [2007], What Is the Market Society, Sophia University
Hirai, T. [2008],
Keynes and the Cambridge
Hirai, T. [2009], The
Theorier of Market Society in Cambridge
Hutchison, T. [2000], On the Methodology of Economics and the
Formalist Revolution, Edward Elgar.
Keynes,
J.M.[1919], The Economic Consequences of
the Peace, Macmillan.
Keynes,
J.M.[1930], Essays in Bibliography,
Macmillan.
Keynes, J.M. [1936], The General Theory of Employment, Interest
and Money, Macmillan.
Krugman, P. [2008],
“Depression Economics Returns”, New York
Times, Nov.14.
Krugman, P. [2009],
“The Market Mystique”, New York Times,
April 01.
Kydland, F. E. and
Prescott, C. [1982], “Time to Build and Aggregate Fluctuations”, Econometrica, Vol.50, No.6.
Lucas, R. [1975], “An
Equilibrium Model of the Business Cycle”, Journal
of Political Economy, 83:6.
Mankiw, N. G. and
Romer, D. eds. [1991], New Keynesian Economics, MIT Press.
Mizuho Research
Institute [2007], The Subprime, Nihon Keizai Shinbun
Shuppansha (in Japanese).
Morris, C. [2008], The Trillion Dollar Meltdown, Public
Affairs.
Ogura, M. and Yasuda, Y. [2008], The Subprime Problem and the U.S.
Romer, C. and
Bernstein, J.[2009], “The Job Impact of the American Recovery and Reinvestment
Plan”, Jan. 9.
Romer, D. [1993], “The
New Keynesian Synthesis”, Journal of
Economic Perspectives, Vol.7, No.1.
Shiller,
R.[2008], Subprime Solution, Princeton University
Stadler, G. [1994],
“Real Business Cycles”, Journal of
Economics Literature, December.
Stiglitz, J. [2009], “Obama's
Ersatz Capitalism”, New York
Times, April 01.
Takita, Y. [2008], The
World Financial Crisis, Nihon Keizai Shinbun Shuppansha (in Japanese).
De Vroey and Hoover
Woodford, M. [2003], Interest and Prices, Princeton
University Press.
Yoshioka, K.[2008], Globalization of China
