Economic Instability and Stabilization Policy: On the Path from Crises to State Directed Economies

233 Pages·2021·2.584 MB·English

by  Ralf Pauly

Ralf Pauly
Economic
Instability and
Stabilization
Policy
On the Path from Crises to State Directed
Economies
Economic Instability and Stabilization Policy
Ralf Pauly
Economic Instability
and Stabilization Policy
On the Path from Crises to State
Directed Economies
123
Ralf Pauly
Institute of Empirical Economic Research
OsnabrückUniversity
Osnabrück, Germany
ISBN978-3-658-33625-7 ISBN978-3-658-33626-4 (eBook)
https://doi.org/10.1007/978-3-658-33626-4
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To Catherine
Preface
ThisEnglishbookisarevisedandexpandedversionofthesecondGermanedition
from2018.BeforethepublicationofthefirstGermaneditionin2015,Istudiedthe
2008 financial crisis. Re-studying Keynes’ seminal work “The General Theory of
Employment, Interest, and Money” and reading Minsky’s basic publication “Sta-
bilizinganUnstableEconomy”contributedtoabetterunderstanding.Togetherwith
Schumpeter’s concept of economic evolution, both books form the foundation for
the present analysis of an unstable economy and government stabilization. A ret-
rospective on economic evolution provides a historical perspective for the discus-
sion of state stabilization, the consequences of which are becoming increasingly
cleartoday,andahistoricalbasisfortheoutlookonfutureeconomicdevelopments.
Theinteractionbetweenthestateandtheeconomynolongerstabilizeseconomic
processes for the common welfare as it did in Keynes’ time. Traditional state
interventionhasnowreached adeadend: growing instabilityandinequalityweigh
on society, distorted markets impair economic efficiency with “evergreening”, and
high uncontrolled credit expansion upsets together with sluggish growth the
intertemporal balance between “much credit” and “fast growth” and reduces
society’s confidence in the future.
Tomakethefuturepromisingagain,thestateshouldrealignitspolicies.Indoing
so,itcaninitiatethetransitionfromamarketsocietytoaknowledge-basedsociety
with autonomous power of initiative. This modern civil society, together with
innovative companies, will be a decisive factor for competitiveness in the inten-
sifying international competitive struggle and for new national welfare.
I would like to thank Günter Bamberg and Lothar Knüppel for their critical
review of the second edition.
Köln, Germany Ralf Pauly
December 2020
vii
Contents
1 Introduction: Views on Economic Crises in the Twenty-First
Century. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1 Financial Crisis at the Beginning of the Twenty-First
Century . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Economic Development in the USA: Competitive Advantages
Through Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.3 Transformation of the Economy . . . . . . . . . . . . . . . . . . . . . . . . 8
1.4 Crisis in the Euro Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1.5 Economic Crises and Stabilization. . . . . . . . . . . . . . . . . . . . . . . 15
1.6 Keynes’ and Minsky’s Economic Approach . . . . . . . . . . . . . . . . 17
1.7 Traditional Economic Policy in the Crisis . . . . . . . . . . . . . . . . . 20
1.7.1 Economic Policy in an Impasse. . . . . . . . . . . . . . . . . . . 20
1.7.2 Reorientation of Economic Policy in Democratically
Constituted States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
1.8 Key Theses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
1.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
2 A Review of the History of the Economy and Its Concepts:
Change Is a Constant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.1 The Agricultural Revolution . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.2 Capital Accumulation, Economic Growth, and Industrial
Revolution (Smith) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
2.3 InvisibleHand,Market,Profit,DivisionofLabor,Productivity,
and International Trade (Smith and Ricardo) . . . . . . . . . . . . . . . 39
2.4 Globalization Versus National Mercantilism. . . . . . . . . . . . . . . . 42
2.5 Market Economy and Market Society (Polanyi) . . . . . . . . . . . . . 43
2.6 Basic Elements of Microeconomics (Walras and Debreu) . . . . . . 44
2.6.1 Market Equilibrium, Price Mechanism, Competition,
and Profit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
2.6.2 Constitutive Elements of Microeconomics
and Their Critical Evaluation . . . . . . . . . . . . . . . . . . . . 47
2.7 Economic Crisis and Macroeconomic Stabilization
by the Government (Keynes). . . . . . . . . . . . . . . . . . . . . . . . . . . 50
ix
x Contents
2.8 Economic Evolution Through Innovation and Credit
Creation (Schumpeter) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
2.9 Economic Instability due to Dominant Financial Market
and Increasing Indebtedness (Minsky) . . . . . . . . . . . . . . . . . . . . 58
2.10 Sluggish Growth and Social Inequality . . . . . . . . . . . . . . . . . . . 59
2.11 Central Bank’s Stabilization Policy in the Context of Weak
Growth, Instability, and Inequality. . . . . . . . . . . . . . . . . . . . . . . 61
2.12 People and the Economy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
2.13 Recent Transformation in the Global Economy. . . . . . . . . . . . . . 64
2.13.1 ICT Revolution (Baldwin and Milanovic) . . . . . . . . . . . 64
2.13.2 Globalization and the Economic Change to the
Disadvantage of the Old Industrial Nations . . . . . . . . . . 66
2.13.3 Inequality, Blitzscaling, and New Monopoly
Formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
2.13.4 Central Bank Policy, Market Risks,
and Moral Hazard . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
2.13.5 The Narrative of the Self-regulating Market. . . . . . . . . . 73
2.13.6 Economic Concepts and Traditional Economic
Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
2.13.7 Globalization and the International Competitive
Struggle (Marx) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
2.13.8 China on the Path of Globalization to Become
a Leading Economic Power . . . . . . . . . . . . . . . . . . . . . 81
2.14 Realignment of Government Economic and Social Policy . . . . . . 85
2.14.1 Democracy, Capitalism, and Prosperity (Iversen
and Soskice) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
2.14.2 State, Economy, Democracy, Society, and Ecology . . . . 87
2.15 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3 Keynes’ and Minsky’s Macroeconomics . . . . . . . . . . . . . . . . . . . . . . 95
3.1 Main Principles of Keynesian Macroeconomics . . . . . . . . . . . . . 95
3.1.1 Basic Concept . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
3.1.2 Commodity Market and Equilibrium Curve IS
in the ISLM Model . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
3.1.3 Money Market, Equilibrium Curve LM,
and Underemployment Equilibrium in the ISLM
Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
3.1.4 Government Intervention to Stabilize the Commodity
and the Labor Market: Fiscal and Monetary Policy . . . . 107
3.1.5 Critical Evaluation of the ISLM Model and the Public
Stabilization Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
Contents xi
3.1.6 The ISLM Model and the Power of Simplification. . . . . 112
3.1.7 Microeconomic Dynamics, Debt Financing, Profits,
and Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
3.1.8 Keynes-Minsky Momentum . . . . . . . . . . . . . . . . . . . . . 117
3.2 Main Features of Minsky’s Macroeconomics . . . . . . . . . . . . . . . 120
3.2.1 Basic Elements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
3.2.2 Interdependence Between Profit and Investment. . . . . . . 122
3.2.3 The Mark-Up Approach and Price Levels . . . . . . . . . . . 128
3.2.4 Evaluation of the Formal Minsky Approach. . . . . . . . . . 129
3.2.5 Finance Market: Private Banks, Debt Financing,
and Instability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
3.2.6 Minsky’s Approach and the Changes in Economic
Activity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
3.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
4 Outlook on the Transformation of the Market Economy
and Its Stabilization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
4.1 Interest Rate Effect on Minsky’s Profit–Investment
Dynamics, on Inequality, and on Monetary Policy . . . . . . . . . . . 141
4.2 Inequality of Income and Wealth. . . . . . . . . . . . . . . . . . . . . . . . 144
4.3 Piketty on Inequality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
4.4 Scheidel on Inequality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
4.5 Private Banks: Equity Ratio, Banking Business, Risks,
and Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154
4.5.1 Equity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154
4.5.2 Banking Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
4.5.3 Risks and Risk Management. . . . . . . . . . . . . . . . . . . . . 160
4.5.4 Basel Banking Regulation and EU Banking Union. . . . . 163
4.6 Debt Financing and Risks: Good Times and Bad Times . . . . . . . 165
4.7 Inflation and Deflation: Good Times and Bad Times. . . . . . . . . . 171
4.8 Capital, Growth and Sluggish Growth . . . . . . . . . . . . . . . . . . . . 172
4.9 Globalization: Good Aspects and Bad Aspects . . . . . . . . . . . . . . 174
4.10 Economic Processes and Their Analysis. . . . . . . . . . . . . . . . . . . 178
4.10.1 Levels of Economic Processes . . . . . . . . . . . . . . . . . . . 178
4.10.2 Quantitative Numerical Analysis . . . . . . . . . . . . . . . . . . 181
4.10.3 Understanding Using Partial Models . . . . . . . . . . . . . . . 186
4.10.4 Formal Quantitative, Qualitative Analysis . . . . . . . . . . . 188
4.11 Stabilization Policy in the Post-Keynesian Era . . . . . . . . . . . . . . 189
4.11.1 Central Bank Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
4.11.2 Monetary and Fiscal Policy in the Eurozone . . . . . . . . . 193
4.11.3 Profits and Losses of Central Banks . . . . . . . . . . . . . . . 197
xii Contents
4.12 Consequences of Economic Change and State Stabilization:
Instability and Inequality, Distorted Markets, and Intertemporal
Imbalance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
4.13 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
5 Conclusion: Changing Economic Policies . . . . . . . . . . . . . . . . . . . . . 209
5.1 Economic Crises and State Intervention . . . . . . . . . . . . . . . . . . . 209
5.2 On the Path from Crises with Old Methods to State Directed
Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214
5.3 Reorientation of Government Economic and Social Policy . . . . . 218
5.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221