With the coronavirus threatening complete economic collapse, it might seem a bit pointless to keep churning out these weekly posts. But in fact, the current sequence of posts is going to lead seamlessly into an analysis of what we can learn from the reaction of financial markets and Central Banks to the crisis.
And in any case, we are going to need a concerted, coordinated global effort to rebuild the economy. What does that remind you of?…
Last week I introduced the Marshall Plan as a state-planned, state-funded approach to the economic development and reindustrialisation of Europe after the Second World War. This week I want to draw out lessons in terms of the redistribution of funding from a country with a trade surplus (the US) to countries that were in deficit.
The European nations had been devastated by a war fought in their actual territories. The Plan could be seen as the US taking advantage of its stronger condition to help its war-time allies, and therefore willing to fund this reconstruction. However, a significant share of funding went to Germany (and also to Japan through the equivalent plan in Asia). The US had recognised that their own economic progress depended on strong economies in Europes, and likewise that the economy of Europe needed Germany to regain its industrial strength.
As mentioned, the US was in a much stronger economic position. It’s industries were not affected by the war and therefore it had significant a trade surplus. Hence, it had the wealth to fund the plan. The US also needed other countries to have a way to earn income to be able to buy US products. The Marshall Plan effectively transferred part of the US wealth earned through its trade surplus to the European nations, who were then obliged to buy US products as part of the conditions of the funding. This fits perfectly into the framework presented elsewhere in the blog. First of all, this was “demand-side” economics. But the point I want to draw out in this post is that the Plan was recycling wealth from a trade surplus to deficit countries. I’m not saying that this was a conscious purpose of the Plan (it may have been, I just don’t know), but whether it was or wasn’t, this was how the Plan operated in practice.
A trade surplus forms part of the national saving of a country. The central point of the “Productivity” section of the blog is that saving needs to be directed to productive investment to retain its value, and that this is an essential aspect of creating an economy that provides enough for everyone. When I drew some tentative conclusions at the end of the “Financial Markets” section, the 6th of these was the need to redistribute trade surpluses to support global economic development. In part this drew on the work of Pozsar, who identified the destabilising effect of giant institutional cash pools (holdings of surplus wealth in excess of $1bn). One source of such pools is the foreign currency reserves of central banks in countries with a trade surplus, and Pozsar suggests that these surpluses need to be redistributed (purely for reasons of economic stability, not for any notion of redistributive justice). Achieving this is next to impossible without a high degree of global agreement, cooperation and even global institutions (discussed further in this post).
The Marshall Plan is an example of this actually happening. The Plan was specifically and explicitly focusing funding into investment in industries likely to stimulate greater industrialisation and economic development. And the source of that funding was a country with a trade surplus. I don’t know whether participants of the time were conscious that the Plan was recycling a trade surplus, but this is how the Plan worked in practice. The funding was allocated according to a plan agreed by all the nations involved in a spirit of cooperation (through the OEEC). This provides a model that needs to be followed in the future.
When I started the blog, I intended to have a section on foreign exchange, but subsequently decided to skip this as it was taking too long to cover everything I wanted! Instead, there are brief descriptions of how the foreign exchange system works (e.g. here and here). But in fact, as a direct result of clarifying my thoughts and writing the blog, and through further study since I began (in particular more in depth research into the functioning of global financial markets) I now see how vital understanding this system is to an understanding of the economy as a whole. I’m not now going to add in a section of the blog on Foreign Exchange, but hope this brief example of the Marshall Plan exemplifies what I was trying to say in those earlier posts. I will come back to this concept next week, and in the closing posts of this section.
Of course, today many of the richest countries actually run trade deficits – the US and UK stand out as prime examples. I’m not seeking to let them off the hook, they also need to provide their share of the investment funding for global economic development.
But here I’m making the systemic point that where countries have trade surpluses, these need to be recycled into productive investment in the poorest countries. By “systemic” I mean that this is necessary for the health of the global economic system as a whole, and that everyone benefits when this system is healthy, including the surplus countries. I’m not even attempting to argue that they should do this out of the kindness of their hearts, I’m saying that this is in their best interests. And therefore I feel that it is not accurate to term this transfer of capital as “aid” or “charity”. This is the third and final lesson I want to draw out from the Marshall Plan, which I shall address next week.
