Economic Policies for an Incoming Labour Government (Part 5 of 9)
Mon 2nd Mar 2015
In studying what actually happened and then testing various explanations for consistency with the observed data, Professor Richard Werner of Southampton University has placed himself firmly in the first tradition in Western economic thought. That first tradition, dating from the time of Adam Smith, derives economic conclusions from detailed observation and inductive reasoning based upon the observed facts and data analysis. The second tradition, most highly developed in the 20th century with the development of mathematical economic models and more lately computers, develops a body of deductive reasoning based upon stated theoretical propositions.
The “bottom up” tradition of observing what is happening, building economic understanding on the foundation of the observed circumstances or measured data, and arguing from the observations or the data to the economic theory is exemplified by Adam Smith’s, The Wealth of Nations. An example of his technique is his reference to the productive power of specialisation, which he establishes by referring to the workers in a pin factory, and demonstrating how, by breaking down the elements of production into their constituent parts, a few specialised workers can create thousands of pins a day when one man could hardly produce one pin per day on his own. Smith’s book is a major illustration of the major scientific principle - revived in the Renaissance - of learning by observation, extracting the particular principle from the general, and basing theory upon precise, real-world, observation.
The one common factor in the work of Adam Smith, and of John Maynard Keynes, Osamu Shimomura, Kenneth Kurihara and Richard Werner is that they all belong to the first tradition in economics, the derivation of valid theory from detailed observation. Smith in the pin factory; Keynes in his observation that labour markets, left to market forces, do not produce full employment; Shimomura deriving the economic model for Japan from his observation of the productive force of credit creation in the USA from 1938-44; the Japanese-American Kurihara - examining and discussing the Japanese economic miracle in close-up while acting as the Fulbright Professor to Tokyo University in 1965; the German-born and Japanese-fluent Werner in Tokyo, working from the Bank of Japan financial data about credit creation in Japan, and analysing it into its three key functions of investment credit, financial credit and the presence (or lack of) consumption credit, and then proving the predictive linkages using Granger causative analysis - the work of all these economists is located in the great inductive tradition of economics.
The second and more recent tradition in Western economics is the “top-down” approach. This starts from explicitly stated but theoretical assumptions and then proceeds logically from these to policy recommendations, using deductive reasoning and highly developed mathematics. A number of assumptions are made - that consumers and investors act within perfect markets, with access to perfect information, in a world in which perfect information has leveled out local differences. On this basis, deductive logic arrives at economic models which appear to have great logical validity but which - as Keynes asserted - may bear little relation to reality. In view of the imperfect outcomes of this second approach, as evidenced by the declining fortunes of many western economies, there is much to be said for a return to the methods used by Adam Smith and his great successors.
Three Practical Illustrations of the Use of Credit Creation
As we have seen, if credit creation is left to the tender mercies of self-interested commercial banks, credit will be largely devoted to gambling on property creating a housing and other asset bubbles so as to maximize profits for private shareholders while the real economy languishes for want of adequate liquidity and investment capital, and the economy as a whole is handicapped by a shortfall in effective demand.
An incoming Labour government, however, fully understanding the use of credit creation in the public interest, could resolve many outstanding problems. We provide three examples of the way in which this would work to achieve quite different kinds of objectives.
The Acceleration of British Economic Growth Through Higher Investment
This aspect of central bank credit creation is by far the most potent policy within a government’s control. It would allow the government to create earmarked investment credits, cost-free, for use by SMEs and other private companies to ensure the fulfilment of the Government’s economic, social and environmental policies.
The provision of these funds would be directed by the Bank of England, reflecting advice from the Treasury - a technique described as “Window Guidance” when used by the Bank of Japan in using similar mechanisms in the 1960s and 1970s. There would need to be a bank which was, or ideally a number of banks which were, prepared to use its local branches as taps for local investment (as the Sparkassen in Germany are) and not just as currently occurs - as drains to collect local saving, taking it away for whatever fashionable policy use the London HQ decides.
The initial creation of credit could be at the level of about 10% of GDP, that is about £150 bn a year; multiplier effects might create an eventual new level of commercial and industrial funding of about £300 billion. We would expect these funds to be initially used to provide an improvement of about £100 billion in business liquidity, about £100 billion in early new plant and equipment investment and about £100 billion in funding higher levels of raw materials, working capital and work in progress. If the usual level of tax take of 42% applies to the new investment and to work in progress, government revenue receipts could increase by about £84 billion - an excellent return to government in addition to the overall benefit to the economy as a whole. Furthermore, that new investment would produce a permanent increase in output of about an extra £100 billion a year, equal to a permanent increase in GDP of about 6.7%, and a permanent rise in government revenue of about £42 billion a year. We think these changes would occur within about two years.
Some economists have traditionally argued that, because an extra job in manufacturing industry has historically created another job in the service industries, the final effect could be twice the initial stimulus. It is indeed likely that placing the economy on a higher growth path will enable the under-performing assets and spare capacity in our industries to respond to the higher levels of demand created by this stimulus.
The experience of other countries shows that investment credit economics works by creating wealth in the productive sector of the economy. The loans made are almost completely repaid (the failure rate is typically about 2.5%) out of the growth of the economy resulting from the additional investment. The failure rate of these loans matters little in any case because the loans cost nothing to create; their consequences matter, however, because they produce their targeted effect in reducing poverty, stabilising the banking system, and creating widespread prosperity through many flourishing private industries in all the areas of the country.
The increase in output would obviously negate the risk that a substantial increase in the money supply could be inflationary, as Keynes recognized and as the Japanese experience in particular demonstrates. The consequence of the increased money supply could well be a fall in the international value of the pound, which could only be helpful in ameliorating the competitiveness problem of British industry and in ensuring readily available markets for increased British production.
Unemployment will fall to a low level. Social security payments will automatically reduce as fuller employment becomes the norm and Government income will cease to be disappointing, ending the need for austerity in government expenditure and bringing to an end all of its ill effects for our people.
© Bryan Gould and George Tait Edwards 2015