Letter in FT Published: November 12 2008 02:00 Sir, Nobel Prize-winning economist Edmund Phelps (November 5) argues somewhat awkwardly that “Keynes had no sure cure for slumps” for three reasons: that public sector infrastructure investment spending (to create employment) lacks productive innovation according to “capitalism theory”; that near the end of his life John Maynard Keynes told “his friend Friedrich Hayek” that he was going to revise his theory in his next book (never completed); and that Keynes failed to distinguish a fall in asset prices “springing from ... autonomous increase in demand for money”, which in Professor Phelps’ view is solvable by simply increasing the money supply (whereas Keynes, according to Prof Phelps, only focused on non-monetary reflation measures).
Prof Phelps claims all this “stresses how important it is that owners of financial and business enterprises be accountable to no one (except their own consciences) – thus free to use their intuition”. This is extraordinarily bold when we know that ownership of major enterprises is not discrete but dispersed, and that intuition and conscience have failed spectacularly this time. Implicit in his view is that governments have no rights and obligations that may need to prevail in recession or financial crisis conditions.
How can it be that Keynes failed to see a role for monetary measures when deficit spending by government is also a monetary measure, of which Keynes is well known as the leading exponent? Surely there is no such thing as a “capitalism theory”. There are only abstract theories of markets and companies as reduced-factor micromodels. The macroeconomy, however capitalistic, necessarily includes government, the body politic, systemic risks, security and stability issues, social goals, religious morality, international diplomacy, trade and payments, all incapable of being fixed in any theory.
We do not have a pure or fundamentalist theory of capitalism and we should not want to have one. This is capitalism’s flexible strength: that it cannot be religiously defined, neither protected from politics nor worshipped as if it is the One God whose abstract precepts are sacrosanct at all times in all circumstances.
Robert McDowell,
Edinburgh, UK
Note: Phelps’s current work idealizes the benefits & wellsprings of a country’s (structural) dynamism – that he foxuses only on enterprising creativity of entrepreneurs (including financiers) in selecting and supporting the best projects, and knowledge managers draw in adopting ever newer methods and products. The difficulty with this peon to innovation is that it is also a testable fashion that will be undermined by each succeeding fashion and not before it has hit a logical balloon that bursts. Phelps sees every dynamic economy having some periods in the doldrums, but even undynamic economies may rise to enjoy extraordinary opportunity. Great dynamism, he argues, brings advantages in every dimension of economic performance (while others might argue that conditions for such dynamism also carry short term social costs and if dynamism is a high frequency of succeeding and constant change then there can by high dysfunctionality costs because little has to be proven over adequate time before the next wave of change is upon us), not just productivity; challenges presented to creative and evolving business provide most people with their main exploration, exercise and development of talents (but that suits some and not all, when some also seek stability, security and some qualities of constancy in socio-economic values). In advanced economies this is the best reason why policy must aim to support business of high dynamism and broad inclusion (while on this point others may argue that some business and public services including utilities are better for being undynamic and dependable). Phelp's earlier work posited many useful theorems for further empirical testing. He is known for seeking to imbed the Phillips Curve that associates two dependent variables as if they directly depend on each other (when they don't if looked at in full economic models), unemployment and inflation, which became a mantra for modern monetarism in the '70s to the '90s and of general equilibrium theory.
Phelps sought to find institutional lag effects that explain the correlation and thereby resuscitate a new context for Keynesian precepts. I view his contribution highly in quality terms but lacking full-scale economic models and too hung up on productivety, the classical (since ASdam Smith) explanation for economic growth, rather than understand the whole system of capitalism including urbanism as a dominant engine of growth as, or more, important that industrial production (my theory). But Phelps did give due credence to social welfare as an engine of growth and wealth, social wealth, which is unusual for economists many consider to be conservative ideologues.
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