Macroeconomics needs to focus on managing abundance and not scarcity

Macroeconomics as a formal part of economics is less than a 100 years old. The economy viewed as a whole became a subject of systematic study only after the Great Depression of 1929-37.

The increased appeal of communism from the Soviet Union was a major catalyst. Until the Great Depression, economists thought all markets would adjust automatically. And they would have, too, given time as indeed they used to. But no one knew how much time it would take.

So Franklin Roosevelt in the US and Adolf Hitler in Germany, independently decided that the government would help the markets adjust. Towards this end they started massive public investment programmes in 1933.

Three years later, John Maynard Keynes, an English economist, came up with a theory that validated this approach. He didn’t use any data, by the way; just logic.
 

Read Part 1: It's a mystery why economists persist with imperfect methods of economics
 

The Roosevelt and Hitler experiments, by the way, were a reversal of the RCT method. The experiment was done before the theory came along, thus anticipating RCTs by 65-odd years. After World War 2 ended, public investment as a stabiliser of the economy became the policy norm — primarily because it appealed to politicians, who wanted to de-risk the labour market by eliminating or greatly reducing uncertainty.

They would spend taxpayers’ money and take credit if things went well. If they didn’t, the next government would have to clean up the mess. This is what has happened to the two Modi governments since 2014. It is still cleaning up.

But leave that aside. The more important question is how the discipline has itself developed? 

Did it factor politics in or did it ignore it, thus imbuing macroeconomic theory with a set of autonomous rules of fiscal and monetary policies, the extent of application of which was entirely discretionary in the hands of politicians?

Read Part 2: The irony of microeconomics: Excess supply and a study of scarcities
 

As far as I am concerned, that was the end of Keynesian macroeconomics as an intellectual exercise with political overtones. It’s now become a political exercise with intellectual overtones.

The political objectives of macroeconomics are essentially of minimisation, and not maximisation by which lay at heart of pre-Keynesian economic theory. The two variables that need minimising are unemployment and inflation. These are mutually contradictory objectives.

But how consistent is this political objective with economics? Short answer: it isn’t, because the same problem that confronts microeconomics, namely, an over supply of the three factors of production and output, confronts macroeconomics even more brutally.

The contradiction in macroeconomics is that it seeks to minimise long-term objectives — unemployment and inflation — with short term instruments like fiscal and monetary policy that need continuous adjustment, like driving a car. All this is fairly well known, or should be. But macroeconomists have refused to acknowledge the political aspects.

Overall, macroeconomics deals with six interdependent variables that move in opposite directions: interest rates, exchange rates, the balance of payments, the fiscal deficit, inflation and unemployment. To minimise one, you have to maximise three or four of these variables, of which two actually need to be minimised at the same time!

So in the end, macroeconomic policy is no more than the management of such contradictions and macroeconomic theory offers few solutions. Academic economists, meanwhile, prefer to stay clear of it.

Let me conclude this series with an agenda for the discipline because even though 20 of the 21st century’s 100 years have gone by, 80 still remain.

Why not devote the next 20 by thinking about the management of abundance rather than scarcity?

Macroeconomic theory has to be constructed around this now, not the old Keynesian identity which took deficiency as its starting point. Policy will follow the lead.

Twitter: @tca_tca
 
This is the third and concluding part of a three-part series. Read part 1 here and part 2 here