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Reflections on Kaldorian economics

Hector McNeill1

Nicholas Kaldor (1908-1986) was an outstanding economist and, although a Keynesian, held views and developed work exposing his awareness of the role of technology in economic growth. He was also steadfast in his opposition to the breed of monetarism introduced into the United Kingdom by the Thatcher government. Most of his reasoning has proven to be correct.

Nicholas Kaldor (1908-1986)

©Cambridge Journal of Economics
In his inaugural lecture as Professor of Economics at Cambridge University, in 1966, Nicholas Kaldor described what has become the Chinese growth model.

Later he became highly critical of the whole underlying basis of monetarism and in particular the assumption that inflation stems from money volumes.

He also was critical of the take up of Hayek and Friedman's approach to monetarism in government which through "liberation" of financial regulations was an underlying cause of the undermining of our manufacturing sector and with this all opportunities for real incomes growth.
In reviewing notes from the late 1960s I now see that much of what is in the spirit of the Real Incomes Approach can be found in the work of Nicholas Kaldor. He gave a very interesting inaugural lecture as Professor of Economics at Cambridge in 1966 and I only attended one seminar given by Kaldor as a post-graduate student. However, this was memorable because I found it to be highly instructive, more so, I might add, than the presentation of other Keynesians such as Joan Robinson. I think the reason was that his exposition was easy to follow and showed a transparent connection between micro level operations and the macroeconomic consequences of their actions and vice versa.

An emphasis of technology and productivity

On the other hand, there was another reason. My undergraduate work had been at the School of Agriculture where most economic lecturers were agricultural economists working for the National Agricultural Advisory Service (NAAS). I was therefore accustomed to the macro-micro integration relationships as a result of our training including farm optimized planning associated with the NAAS role as disseminators of best practice to increase farm productivity and real income across the sector. Economic growth was therefore intimately linked to technological innovation and productivity. This is why I found Kaldor's approach rational and easy to understand.

Kaldor emphasized the significance of manufacturing as the engine of growth and that the root of Britain’s economic problems was the slowing rate of growth of its manufacturing sector. He considered manufacturing to be important for two reasons:
  • It induces productivity growth within manufacturing due to static and dynamic returns to scale

  • As more labour is absorbed into manufacturing, productivity rises in the non-manufacturing sector which has surplus labour with the marginal product of labour less than the average (diminishing returns)
He also articulated the significance of exports as creating a virtuous circle of growth via induced productivity growth and accelerating output growth creating the conditions for faster productivity growth, more competitive products and maintenance of export growth. All of this paralleled the logic applied within the agricultural sector. This process is also the basis for developing better data to take decisions (explicit knowledge) that accompanies a process of managers and work forces becoming ore competent in what they do as they descend the learning curve (tacit knowledge).

Putting monetarism in its place

Kaldor was also an early opponent to monetarism and most of what he stated against monetarism turned out to be correct in practice and he was one of the few economists to disagree with the doctrine of the monetarists and he led the intellectual assault worldwide against the monetarist view that inflation is always and everywhere a monetary phenomenon in a causal sense caused by excessive government expenditure financed by money creation. The development work of Real Incomes Approach had established in 1976 that inflation is not a monetary phenomenon but more closely related to productivity insufficiency. On the other hand Kaldor had a more fundamentally logical reason that because money is largely made up of credit which comes into existence because it is required then money is endogenous to an economy, not the causal factor in the determination of output and prices. Our own work is complementary and added more explicitly that if credit is going into productive investments then this cannot cause inflation but rather deflationary conditions leading to higher real incomes. This is implicit in Kaldor's work.

Although, in line with Phillips Curve evidence Kaldor considered the major cause of inflation in mature industrial countries was rising wages and other costs.

Again our own work on Real Incomes provides a contributing logic. This is why it is somewhat puzzling that while working with Keynes and Beveridge, Kaldor did not make the inflation issue subject to instruments designed promote technological productivity rather than to common instruments such as interest rates and taxation. The Real Incomes Approach to economics does provide some of these missing pieces.

Kaldor was an open critic of Mrs Thatcher's embrace of Friedrich von Hayek and Milton Friedman with exchange rates allowed to float to dangerously over-valued and the engine for growth, the manufacturing industry allowed to crumble, and virtually all controls removed from the financial sector leading directly to the 2007 crisis.

364 economists made no alternative propositions

In 1981 Cambridge economists Frank Hahn and Robert Neild wrote a letter criticising Sir Geoffrey Howe’s Budget. They intended to send it, signed by just the two of them to the The Times, but it grew into a "statement" signed by 364 economists that created rather a stir when published. The statement drafted on March 13, 1981 was,

"We, who are all present or retired members of the economics staffs of British universities, are convinced that:

(a) there is no basis in economic theory or supporting evidence for the Government’s belief that by deflating demand they will bring inflation permanently under control and thereby induce an automatic recovery in output and employment;

(b) present politics will deepen the depression, erode the industrial base of our economy and threaten its social and political stability;

(c) there are alternative policies; and

(d) the time has come to reject monetarist policies and consider urgently which alternative offers the best hope of sustained recovery."

Although the Conservative government budget proposals in 1981 were a turning point in British macro-economic policy-making it led to a cascade of prejudice under increasing financialization and collapsing balance of payment, lack of productive investment and 50 years of gradual depreciation in real value of wages. It is fair to say, first, that the overwhelming majority of British academic economists disapproved of the 1981 Budget.

It is, however, notable that in spite of claiming there was nothing in current theory to support this budget logic they did not make optional proposals for example based on a Kaldorian alternative or even make reference to a real incomes alternative. As a result there was no substantive follow up and this simply deteriorated into a media discussion based on assertion identical to those that were initiated in the 1970s between Keynesians and monetarists.

In such scenarios politicians receive to evidence or options so, whoever is in government can do what they want with Bank of England backing. So such a letter was to no avail and simply no more than a statement to be ignored.

Monetarists have retorted in various intervening periods when some blip indicated something momentarily positive in the economy, attempting to point out the lasting advantages of Thatcher's policies. However, in the context of the real world and hegemonic forces, that is, looking at the long term i.e. 40 years since that budget and accomplanying "reforms" the cascade of decisions and events emanating from that period and ending up in QE, have been a disaster.

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