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I was bowled over. This weekend I read a report which actually managed to explain what the real cause of today’s economic crisis is. The report went one step further too, and outlined a fix. This is perhaps the most important economic report I have read in a very long time.

I covered an aspect of the report on Friday, but over the weekend I have been reading it in more depth, and the more I read it, the more I like.

The reported was penned by a number of academics including Nobel Laureate Joseph Stieglitz. To read it in full see: Sectoral Imbalances and Long Run Crises

For an easier to follow account, read this piece by Stiglitz in ‘Vanity Fair’: The Book of Jobs

I have never swallowed the idea that today’s crisis was caused by banking excess, by greedy bankers.  Instead, I have felt the banking crisis of 2008, and the problems exposed by it, were symptoms, not causes of the deeper crisis.

There are three theories about what caused the Great Depression. Theory one, advanced  by Keynes, is that this was a crisis of demand: to get the economy moving, governments needed to borrow from companies and individuals who were saving more than was economically optimal, and spend this money. Theory two, advanced by Friedman, says that the Depression was caused by a shrinking money supply, caused primarily by banks being allowed to go bust. Theory three, advanced by Hayek, suggests it was all down to government interference –  for there to have been recovery, the government just needed to do nothing, impose less regulation, and let markets force the necessary adjustments.

The theory that seems to have gained sway is the second one. Before he was chairman of the Fed, Ben Bernanke was just about the leading academic in the world on the link between monetary policy and the Great Depression.

Justification for the banking bail-out and for quantitative easing is based on the monetary explanation.

The Keynesians say it took the spending that came with World War 2, which was a kind of Keynesian stimulus by default, to create the post war boom. They go further, and say that in democracy, the Keynesian stimulus required to end a Great Depression type scenario would not occur in peace time, for the electorate would never countenance it.

The followers of Hayek say the recovery from the Depression was occurring anyway, and that Roosevelt’s meddling with a New Deal, just delayed recovery. Keynesians say that Roosevelt’s new stimulus lacked ambition.

The report that has me so entranced, very much falls into the Keynesian camp. And as an aside, it said that Argentina was not involved in the World War, hence it did not enjoy the massive Keynesian stimulus and structural changes, so its recovery from depression style conditions was much slower.  (I find that idea pretty fascinating in itself, and will revisit that idea at a later date.)

The report says the cause of the Great Depression was innovation in agriculture, leading to lower food prices, leading to job losses and lower incomes in the rural economy. At that time, the rural economy was vital to the overall strength of the US, and – thanks to the fall in farm wages – demand for manufactured goods fell. Consequently, the urban economies which relied on manufacturing also slumped. Furthermore, because of falling asset values in the rural economy, struggling farm labourers could not afford to migrate into the cities, even if jobs were available to them.

Or to put it another way, the Great Depression was caused by the changeover from an economy based on agriculture to one that relied on manufacturing. A factor at play here was the specialisation of the labour force. It was geared towards agriculture, and did not have the expertise to move into manufacturing.

The report said that Word War 2 had two effects. Firstly, it created the demand for a US manufacturing industry, and second it forced labour to migrate from the countryside. The report refers to this second effect as structural changes.

Now forward wind the clock today. The report suggests that over the last decade or two, manufacturing productivity has been increasing much faster than wages. This has meant that demand was struggling to keep up with potential supply. A temporary fix to this problem was the credit bubble, and housing boom, but with the banking crisis of 2008 this temporary fix came to an end.

The report says that QE is not working and the banking bail-out may have been an error, because neither fixed the underlying problem.

In the 1930s, the US was changing from an agricultural dependent economy to one based on manufacturing. Today, suggests the report, the shift is from manufacturing to services. I get that. Innovation surely does mean manufacturers can produce more goods from a smaller workforce.

But countries that try to hang on to manufacturing, may themselves be making a fatal error – make a note of that Germany.

The report concluded that the future of the US economy lies in more jobs going into education and health. I guess that means higher taxes to pay for this. And in the short run, it means massive fiscal stimulus.

Finally, there is the role of the entrepreneur. The report did refer to this, and acknowledged than the banking sector has ceased to be effective in providing funding to budding entrepreneurs. But that’s where my criticism of the report lies. Actually, that’s not fair because the report was focusing on the US.

For the UK all the above makes sense, but I would put more emphasis on encouraging greater entrepreneurial activities via QE funding programmes designed to create more entrepreneurs. And if some of these entrepreneurs are hairdressers that does not matter. We can’t all be hairdressers, but an economy in which advances such as 3D printing means less need for manufacturing jobs, we will either have permanently high unemployment, or more hairdressers, personal trainers, teachers and nurses.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Showing 6 comments

  1. Michael

    Your article is very pertinent to our times.

    But is it not the case that both education and health are both stunted very severely by the total domination of the public sector?

    Health is clearly problematic in terms of funding (although I hear that the French system is better than ours and still considerably more privately run and co-funded). Anyway, let us leave that to one side for the moment.

    Schools is a far simpler area for radical peacetime change.

    The voucher system for schools combined with privatisation (a la the railways operating companies) would create an enormous driver for innovation.

    And before anyone says that the state has to provide these essential services… I will counter with: Food. The government DOES NOT provide food to children. It is done via the private system of Tesco, Aldi et al. And basically it works and it is inexpensive. And it is innovative. (And, BTW – unemployment and the various benefits do not generally lead to starvation, so the public funding of food for those that need it works successfully too).

    On the other hand let’s look at the lack of innovation in another similar part of the public system:
    Our local library system (which is publicly run) is still debating whether and how to provide wi-fi. Apparently the director of Library Services has been pushing for wi-fi for over 9 months (wow!) but the powers that be can’t decide on whether of not they should charge for it…..
    Yet all of this costs almost nothing. It is barely worth debating and most businesses would just get on with it (just as they have – wifi is almost everywhere now – cafes pubs, etc.. But NOT the libraries in West Sussex – and yet the internet is one of the greatest sources of learning and what else are libraries for if not learning…..)

    I rest my case.


  2. Charles
    Some interesting observation especially about the library and wifi. I travel to Poland quite a bit and I noticed that wifi is everywhere and free. What is interesting is some companies like airports tried to charge for it. All that happened was the coffe shops at the airports offered it free and people followed. Charging for wifi is madness in my opinion. I have noticed similar in pubs in the UK that use the cloud. Most people stick with 3G as it is too much hassle signing in etc. people treat and use the wifi as a convenience tool. Simplicity is the name if the game.

    regarding michaels article I find the point about stimulus being wasted via QE very interesting. It wonder how much of the changes in the economic of the world is driven by the web? After all if you look in isolation at the UK high st it is the web that has changed things and undermined this area.

    I guess we need a new economic model for the 21 century.

  3. “I guess we need a new economic model for the 21 century.”

    Michael – I’m a bit disappointed that you did not follow this up…

  4. Michael Baxter


    I am not sure what you are suggesting here. That we should all pay for education, or simply that it should be free for users, but supply subject to competition.

    If you are suggesting the latter, then I guess you may be right.

    The issue you need to look out for re education is that the decision as to what school a child goes to is the parent’s, but it is the child whose future is at stake. The state has to do what it can for those who are disadvantaged by parental choice.

    According to Malcolm Gladwell in his book Outliers, in terms to creating more opportunity for kids from disadvantaged homes, school holidays are the problem. Okay his study was in the US, but I think his conclusion has merits. Essentially Gladwell provided pretty overwhelming evidence that a child’ home life was key in determining educational success. And in the US this is becoming more important. However, the gap between those with more supportive parents and those whose parents take a less active role in a child’s education grows during the holiday and shrinks in term time.

  5. Michael

    I am suggesting that the supply of education is open to competition and is as de-regulated as possible.

    Governments are (in general) not at all good at supplying anything. And right now they are worse than ever at it due to a very fast changing world.

    And Gladwell is probably right about the school time/parent time/holiday problem and that also needs addressing.

    So what is your model for the 21st Century that takes all this into account? After all, Keynes made his mark not just by writing books, but by advising governments…..

    Over to you, Michael.

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