A man for all seasons

As the trade wars between different nations escalate, there is a realistic chance that the present rules-based economic order–the Bretton Woods system, if you will– put in place after the second world war, could eventually unravel.

As such, no one really knows what is going to be the full economic impact of the recent imposition of tariffs and counter-tariffs. Nevertheless, this “uncertainty” has been likened to the 1930s when the passage of Smoot-Hawley tariffs in the US worsened the Great Depression.

Before the Great Depression, the economy was said to follow Say’s Law that postulated “supply creates its own demand” meaning that the supply-side determined economic activity and that the economy would inevitably create full employment.

Pull-quote: For central banks, this would entail keeping a watchful eye over inflation, something that the Fed, GCC central banks as well as the State Bank of Pakistan have been doing.

- Aqdas Afzal

The Great Depression was an economic catastrophe like no other. Its utter desperation with 25 percent of the US workforce unemployed, was poignantly captured by the photographer Dorothea Lange. The misery caused by the Great Depression compelled the economists of the time like John Maynard Keynes to focus on its causes thereby leading to the birth of modern macroeconomics.

Keynes concluded that capitalism was essentially a “monetary production economy,” where liquidity could occasionally vanish bringing economic activity to a standstill. In a sense, capitalism, Keynes argued, was demand-constrained, especially during recessions. 

To remedy capitalism’s ills, Keynes proposed a role for the state to not only kickstart the economic engine but to maintain a high level of employment. Keynes’ correct diagnosis of the problem ushered in a “Golden Age” of unparalleled prosperity, growth and stability. By the mid-1970s however, Keynes’ ideas had largely been put aside, as “stagflation” was blamed on demand management policies championed by Keynesian policymakers. 

Still, Keynes’ ideas made a comeback during the 2008 financial crisis, when Keynesian policies of making money cheaper through interest rate cuts and quantitative easing were deployed to prevent the recession from turning into a full-blown depression. 

Keynesian policies saved the day as economic activities steadied across most of the global economy within six to nine months. Nevertheless, policymakers attempted to return to business-as-usual as quickly as possible, which meant reducing the budget deficits that had ballooned during the recession.

Keynes’ ideas found policy relevance again with the emergence of the Covid-19 pandemic, the biggest economic downturn since the Great Depression. Many countries used monetary and fiscal stimulus measures to cope with the negative economic effects brough about by the COVID-19 pandemic proving that Keynes’s ideas for state intervention in the economy were still relevant and necessary.

The frequent return of Keynesian policies might lead people to conclude that Keynes’ main policy contribution was providing a remedy for capitalism’s periodic crises. This conclusion is only partially correct as two of Keynes’ insights have tremendous policy resonance for the future of the global economy. 

The first insight has to do with Keynes also being a philosopher-economist, who made a case for a distinction between probability and uncertainty. Keynes anchored his economic analysis within uncertainty, pointing out that it was impossible to have a statistical distribution for uncertainty as uncertainty simply couldn’t be factored into economic models.

The second insight relates with Keynes’s proposal to establish a world-central bank that would penalize deficit as well as surplus countries. In this way, all countries would be incentivised to maintain balanced trade in goods, forgoing “beggar-thy-neighbor” trade policies, which had led to the tariffs in the 1930s.

Like Keynes, economic policymakers would do well to anchor economic policies within uncertainty, especially as economic uncertainty has been unusually elevated. For central banks, this would entail keeping a watchful eye over inflation, something that the Fed, GCC central banks as well as the State Bank of Pakistan have been doing. At the same time, social safety nets would need to be bolstered, while beefing up defense expenditure and foreign exchange buffers. 

More importantly, as the present global economic order reels under pressure, economic policymakers could take a leaf of out Keynes’ book to conceptualize a new, inclusive and fair global economic order that also captures the reality of extant power relations. Such a global economic order would provide a more significant role to “middle powers” like Germany, Pakistan and Saudi Arabia, while also creating more opportunities for balanced trade. 

With the recent constitutional reforms in Germany making way for an unprecedented expenditure of almost 1 trillion euros, Keynesian ideas are about to become fashionable once again. This is pretty remarkable for someone who died in 1946 making Keynes, truly, a man for all seasons. 

- The writer completed his doctorate in economics on a Fulbright scholarship. X: @AqdasAfzal