Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 18 April 2016

Its ideology, stupid

Wolfgang Münchau takes to task in today’s FT the latest example of German opposition, and in particular opposition from finance minister Schäuble, to ECB policies. However I think he ends up missing the obvious target. He discusses the particular problems negative rates pose for Germany’s financial sector, and in his last paragraph writes

“This episode is a reminder that the collective spirit that was so strongly present in the first years of the eurozone has gone. That — not the presence of imbalances or other technical problems — constitutes the single biggest danger to the long-term viability of Europe’s monetary union.”

I would suggest this has the causality wrong. Any collective spirit has gone because of these ‘technical problems’. The biggest technical problem is an obsession with inappropriate collective fiscal consolidation (austerity). In the Eurozone the ECB is being forced to try negative interest rates because it is having to undo the impact of fiscal consolidation. And the man most responsible for this obsession is Schäuble.  

Gavyn Davies nicely sums up my own view about negative interest rates. Without radical institutional and social changes (which may not be desirable), bank profitability puts a limit on how far central banks can go, and for that reason exploring these frontiers could be counterproductive. But the alternative of more QE, possibly directed at other assets besides government debt, is way down the list of effective and reliable instruments for managing aggregate demand right now. Helicopter money is a much better way of giving central banks more ammunition. But the focus right now should not be on any of this, if we are genuinely concerned about social welfare. As John Kay says, “we need less financial ingenuity and more common sense”.

What we should be talking about is why governments are not doing much more public investment. Yet in the US, Germany and the UK any dramatic increase in public investment seems out of the question. Barry Eichengreen, in an article entitled “Confronting the Fiscal Bogeyman”, writes of Germany:

“The ordoliberal emphasis on personal responsibility fostered an unreasoning hostility to the idea that actions that are individually responsible do not automatically produce desirable aggregate outcomes. In other words, it rendered Germans allergic to macroeconomics.”

In the US, antagonism to the Federal government rooted in the past has meant Republican leaders are  

“antagonistic to all exercise of federal power except for the enforcement of contracts and competition – a hostility that notably included countercyclical macroeconomic policy. Welcome to ordoliberalism, Dixie-style. Wolfgang Schäuble, meet Ted Cruz.”

He ends

“Ideological and political prejudices deeply rooted in history will have to be overcome to end the current stagnation. If an extended period of depressed growth following a crisis isn’t the right moment to challenge them, then when is?”

He does not mention the UK, where the antagonism to public investment seems to lack any deep historical explanation, and may just reflect stupidity or an ideology imported from the US.

When I talk about public investment people normally think about big projects, like HS2 in the UK. I like to point out that simpler and perhaps more boring things, like repairing roads, are at least as important, and can be done immediately. But if there is one area above all else where much more needs to be done right now it is investment in renewable energy.

The recent news on climate change is not good. It is foolish to read too much into one or two months figures, but this chart is nevertheless quite scary. It is scary because we know of various possible ‘tipping points’ (like the melting of all Arctic ice or the mass release of methane from permafros) which could accelerate global warming. Most climate models assume we will control carbon emissions in time to stop that happening, but we cannot be sure of that, because we are in uncharted territory.

We know we need a massive expansion of renewable energy, but one problem that has so far stopped that being a complete solution to climate change has been that sometimes the wind neither blows nor the sun shines. We need to be able to cheaply store electricity, but our current battery technology is not good enough. Battery technology is also crucial in making electric cars as attractive as petrol based cars. But technology could come to the rescue. Existing batteries could be made much more efficient, or completely new battery technologies could be made viable. Much more efficient transmission could also help. And if you look at all three links, you may notice one common factor. These potential breakthroughs have all come from research undertaken in the public sector. As Mariana Mazucato has argued, the state is “better able to attract top talent and pursue radical innovation”.   

China put over $80 billion into the renewable energy sector in 2014. That is nearly 1% of its GDP. It has committed to spend 25 times that amount over the next 15 years on clean energy. Both the US and Europe spent much smaller amounts ($38 and $58 billion respectively), even though their economies are much larger (the US figure is around 0.07% of its GDP). In dollar terms, the Chinese government also spent more on Green R&D than Europe or the US. [1] The scope for US and European governments to spend more on researching and help with developing green technology is huge. Yet in the UK the government has recently cut back its support for renewable energy, even though the UK’s need for renewable energy is urgent.

Climate change may be the most important example, but it is not alone. It is absurd that when the potential for technological change leads people to write about robots taking over, actual productivity growth is slowing everywhere. As an IMF report says, "innovation [is] highly dependent on government policies." I think Brad DeLong, in commenting on Eichengreen’s article, has it exactly right when he writes “it is long past time for a frontal intellectual assault on the[se] dangerous and destructive ideologies”.   
[1] If we include corporate R&D, Europe moves ahead of China in $ spend, but China is still ahead of the US.       


  1. I think that "federal power except for the enforcement of contracts and competition " understates the case. I think "federal power except for the enforcement of contracts" is accurate. Republicans reliably oppose any effort to enforce competition (as noted by and Summers and by Krugman today (no link as it might be suspected of being spam))

  2. If Britian leaves true EU there will most likely be a short-term shock based mainly on uncertainty.

    This could be an amazing way to end austerity: fully exposing the lie that we needed cuts to save for a rainy day.

    By bringing on the rain now the next chancellor (let's be honest) can either push for more cuts and loose the conservatives any economic credibility or they can support proper stimulus.

    Right now a bit of tough love in the form of a Brexit might be just what the political system needs

  3. The intermittency of solar and wind does not stop them being a complete solution to climate change.

    Pumped hydro energy storage is an old and cheap way of levelling fluctuations in energy supply. Dinorwig Power Station was built between 1974-84. Indeed, this country planned several PHES schemes before the 'dash for gas' meant the electricity supply could manage peak demand without them. Other mitigations include balancing wind and solar (irradiance and wind speed are somewhat anticorrelated, due to air pressure), spreading the grid over a larger area (European Super Grid) to offset regional shortages, and demand response. Obviously using the above raises the cost of wind and solar, but they are still a complete solution with current technology.

    And, of course, we don't rely just on renewables to provide a complete solution to climate change, because of technologies like nuclear.

  4. The negative ideology is not limited to Germany and other similarly minded countries. The latest recommendations from the IMF include reducing unemployment compensation so that people would take poorer paying jobs. I guess this is directed to the lazy unemployed people in Greece, Spain and other EZ countries. It sounds like something out of Dickens. "Are there no workhouses for the poor?"

  5. Someone should solve for how much solar power plant is required to provide all the necessary power to produce new solar power plant, from excavation through processing, construction, installation and commissioning, to find the yield on solar power investment, equal delta new plant divided by old plant.

  6. It’s the price and profit mechanism, stupid!
    Comment on Simon Wren-Lewis on ‘Its ideology, stupid’

    You say: “What we should be talking about is why governments are not doing much more public investment.”

    What the anti-austerity disputants have on their minds is good old Keynesian deficit spending. That is not wrong per se, but it is wrong for an economist. An economist should have realized after more than 80 years that Keynesian theory is defective. The fact of the matter is that (i) the multiplier arithmetic is fallacious, and (ii), that distributional effects are completely overlooked. Deficit spending is the very profit machine and more than anything else accounts for the observable unequal wealth-distribution.*

    Could it be that it is not a question of ideology at all but that Schäuble has a better economic theory at the back of his mind than retarded economists?

    To cut a longer formal derivation short (2015), the most elementary version of the macrofounded employment equation for the economy as whole is given here:

    From this equation follows:
    (i) An increase of the expenditure ratio rhoE leads to higher employment L (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction of the household sector.
    (ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
    (iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

    The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

    Item (i) and (ii) is familiar stuff since Keynes. What is missing in the flawed Keynesian employment multiplier, though, is the ratio rhoF as defined with (iii). This variable embodies the price mechanism. It works such that overall employment increases if the average wage rate W increases relative to average price P and productivity R.

    The correct employment equation shows that the price mechanism, i.e. the relationship of wage rate, price, and productivity, can be used to increase employment. Thus, there is, as a matter of principle, no need to increase private/public debt or of pushing investment. The crucial point is that standard price theory is provably false.

    Correct economic theory opens new dimensions of economic policy. Or, put the other way round, right policy depends on true theory. Neither Keynesians nor Walrasians, though, have the true theory. In particular they lack a deeper understanding of how the price and the profit mechanism in the monetary economy works. This is what economists should be talking about before they make fools of themselves with inept economic policy blather.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

    * See the posts ‘Keynesianism as ultimate profit machine’
    and ‘Deficit spending, helicopter money, and profit’

  7. I agree we need better storage and transmission - and there are some positive signs of that - but there are some forms of renewable energy that are predictable. One is geothermal, another is tidal power, which is plentiful around the UK. The most advanced proposal is to utilise the large tidal rise and fall in the Severn Channel, initially at Swansea Bay with a larger lagoon between Cardiff and Newport to follow. Between them these could make Wales self-sufficient in energy. Other locations around the UK have also been identified.

    This is still waiting on reports and agreed estimates. The initial lagoon will of course be more expensive that those to follow because it will carry the learning costs but even so it looks as if it would be cheaper and less prone to cost/time overruns (and of course safer) than the increasingly dubious Hinkley Point nuclear proposal, which is so financially risky that EDF's CFO has resigned over it.

  8. .
    Brilliant article, and maybe it is just me, but, this seemed unintentionally humorous:

    He does not mention the UK, where the antagonism to public investment seems to lack any deep historical explanation, and may just reflect stupidity or an ideology imported from the US.

  9. In Spain, home electricity generated by solar power is now taxed!

  10. "The biggest technical problem is an obsession with inappropriate collective fiscal consolidation (austerity)." I thought you were going to say "obsession with inflation". Come on, first things first. If you obsess about inflation you will end up with deflation.


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