Spotlight G-20: We Need Global Keynesianism

Matías Vernengo
Part of a Triple Crisis series leading up to the Nov. 11-12 G-20 meetings.

The expectations for the meeting of the world leaders where huge, but when they gathered no agreement was reached on currency wars, commodity prices or demand stimulus.  As it should be clear, I am not making a prediction about the forthcoming G-20 meeting, but just recalling the failed London Economic Conference, held in the summer of 1933, at the peak of the Great Depression.  Contrary to conventional wisdom, which argues that the conference failed because it was unable to reestablish a credible Gold Standard, the main mistake in London was the incapacity to provide a framework for global expansion, in part as a result of British incapacity, in part as a result of American unwillingness as noted by Charles Kindleberger.

In the absence of such framework, the countries that pursued Keynesian policies domestically were able to recover faster.  Those countries tended to get rid of the Gold Standard’s austerity rules and had a more undervalued currency.  But depreciation and foreign markets were not at the center of the recovery.  Fiscal policy and employment programs, and, thus, the domestic market, were central.

The examples of domestic market successful policies abound.  In Latin America the recovery was largely possible because of a shift towards domestic markets, and an increase in manufacturing production, the so-called Import Substitution Industrialization.  The depreciation was more important as a tool to protect domestic production than as an instrument for the recovery of external markets, which were depressed anyway.  In Germany, remilitarization was an important part of the path to recovery.  In the US the employment programs, in particular the Public and Civil Works Administration (PWA and CWA) and the willingness to accept deficits reduced the unemployment level from 25% in 1933 to 9% in 1936.  Not full employment, but no small achievement either.

But it is still true that the recovery only became global when, as noted by John Kenneth Galbraith, “Hitler, having ended unemployment in Germany, had gone to end it for its enemies.”  The lesson seems to be that before trying to fix the international monetary system, the G-20 countries, in particular Western Europe and the US, should agree to pursue more expansionary fiscal policies at home.  The reorganization of the world’s monetary system in Bretton Woods, and Cold War military spending among other things, allowed for sustainable expansion after the war, but domestic and global demand expansion did not wait for the new financial architecture, and there is no reason why we should do it now.  If not we will have to wait for an external event to get the global economy going again.

5 Responses to “Spotlight G-20: We Need Global Keynesianism”

  1. Kevin P. Gallagher says:

    What is your response to those who say that in 10 years the US will have to pay $1 trillion per year just in the interest on the national debt and thus we should follow the UK/Germany lead for austerity?

  2. Steve Bannister says:

    To whom are you assuming the US will be paying the $1 trillion?

    If it’s mostly domestic, then it will be largely a wealth transfer from US taxpayers to US note and bill holders (and of course a fair amount to the Fed thus recycled to Treasury).

    If there is a significant foreign holding of US notes and bills, then it will be a wealth transfer to them.

    As a US taxpayer, I prefer the first with an offsetting transfer from US note and bill holders back to US taxpayers.

    If it is the second, then big problems for US taxpayers’ wealth and a recipe for increased international turmoil.

    Of course, US growth and a reduction in its negative trade balance would improve on any of the above; So, I am with Matias. US fiscal expansion optimized for US growth.

  3. Kevin, before I could reply Steve got my main point. The US interest burden is all in dollars. That’s the great difference with the pound in the inter-war period, when it lost its international position. In fact, QE guarantees that long term interest rates will remain low and if fiscal spending is done right (say more on infrastructure) and growth picks up, the debt-to-GDP ratio should fall without any need for austerity, as it happened in the post-war era. But as Jerry suggests in his post today, and Krugman did a few weeks ago, the fiscal hawks seem to have the upper hand. The debt commission is the last installment of their attack on fiscal sanity.

  4. Jane D'Arista says:

    Matias, thanks for the reminder of the differences in response then and now. But I would add that the potential for a global fiscal response could make a major difference now. Currency reform is needed to make that happen just as it was in the 1930s when countries went off gold or revalued. It’s interesting that last year’s SDR proposals were lost this year in the furor over the US position on China and other’s concern about QE2. One of the SDR proposals that should be pursued is having the (reformed) IMF issue SDRs by buying governments’ debt (as proposed by Harry D. White in 1944) to add to countries’ capacity to undertake fiscal stimulus by using SDRs held by central banks as reserves to buy the debt. That would also ease the process of reducing deficits and debt over time compared to the costs and volatility involved in using capital flows provided by either private of public sector investors for financing expansion.

  5. Hello! Wonderful stuff, please do tell us when you post again something like this!