In the wake of the Great Financial Crisis, mainstream economics slowly came under attack, amid a decade of mediocre growth, and warnings about imminent inflation that never came to pass. After Covid hit, policymakers took a different path, opting for aggressive fiscal expansion and discarding ideas about austerity. This week's guest has been preaching this message of change for a long time.
Independent economist Steve Keen spoke to us about what economists get wrong about everything , especially regarding climate change.
Tracy Alloway:
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal:
And I'm Joe Weisenthal.
Tracy:
So Joe, one of the themes that we've had in our recent episodes is this idea of the pandemic changing certain perceptions of economics, or certain perceptions of how the world and the economy actually works.
Joe:
Yeah, I think that's exactly right. We just got in the U.S., for example, Personal Income and Spending data, and the story is that income replacement has been extremely effective and successful in the U.S. And that's not what you expect in a recession. I think people started opening their minds to like how much of what we take for granted vs. what is a policy choice.
Tracy:
Absolutely. One of the big things that happened is we had the Covid shock in 2020, and we finally had this exogenous shock that economics is kind of obsessed with and things didn't necessarily pan out exactly the way that a lot of economists would have expected based on traditional principles of how things actually work.
Not only have we had an unusual crisis in many respects, but now people are talking about an unusual recovery as well, and whether or not the future economy is going to look slightly different. So with that in mind and I guess without further ado, we have the perfect person to talk about, all of this. An iconoclastic economist if ever there was one, and someone who thinks slightly differently to a lot of other economists out there, we're going to be speaking with Professor Steve Keen.
He's a distinguished research fellow at the University College London and also the world's first crowdfunded economist. He has a Patreon account where he posts a lot of materials, you can check that out. Professor Keen, thanks so much for coming on.
Steve Keen:
Thank you. Thank you for the invitation.
Tracy:
So I guess I'm trying to think where to start, because of course your research is quite wide-ranging and if we're going to talk about the entire state of the current economy, that's a pretty big topic, but maybe just to begin with, talk to us about what surprised you over the past year, or what stood out to you in terms of economic development?
Steve:
In some sense, I wasn't surprised because when the crisis first hit, I get on my Patreon blog and wrote that we should have the government pump as much money as they can into the economy to make it possible for people to not to have to go to work and not go bankrupt through the whole process. And I suppose in one sense, it's not amazing that when a crisis strikes like this economic textbook gets thrown out the window — where it desperately deserves to be thrown by the way.
And that people who just, as I know, from what Hank Paulson had to say back when the financial crisis hit, he wasn't going to let capitalism collapse on his watch. So they throw the government money book at the system. Now of course that happened back in the Great Recession as well, but we very rapidly switched over to balancing the government's books and all this sort of stuff.
This time round the scale of what was done has been two or three times as big as what happened with trying to reduce the damage from the Global Financial Crisis. And actually a lot of Americans ended up getting a pay rise out of the fact that 600 bucks from the government to meet their bills for a while. And I think what actually has started to soak into people is that, “Hey, maybe the world's financial system doesn't work the way the textbooks told us it works.”
So I think that's the pleasing thing that I take out of this, that there's more consciousness that that textbook explanations, the Bank of England itself said in 2014, is simply wrong.
Joe:
Do you think this is a lesson that's actually been learned? Like, sure, we can all observe this. We can all look at household incomes, having held up despite the crisis, we can look at the robust power of fiscal policy. But do you think this is a lesson that will actually be learned? Or do you think it's a lesson that will be dismissed? You know, “Oh, that was a weird crisis because it was this exogenous shock. It was a health thing. We have to go back next time in a downturn. We have to go back to the old way.”
Steve:
I'm already seeing this happen in the literature, particularly amongst U.K. politicians of both Labor and Tory stripes. They're both talking about the need to “balance the books... Our future generations are paying for our splurge during Covid.” But I think that the scale of this was so big and the public impact so great that it's going to take longer for that conventional message to be accepted as it was in the past.
And I think in some ways they're not going to get a chance to do that because as soon as 2020 was out the door “Thank God it's not 2020 anymore,” 2021 said, “Hold my beer. I'm going to set fire to Canada.”
And what's happening right now is making people think that a whole lot of things they took for granted do not work the way that they have been assured they do. And that includes how economists have said that climate change is no big deal. So I think Covid was a warm-up saying that we have to do something to drastically change our impact on the planet and what we did during Covid — governments got the capacity to finance it — it creates money when it spends. And that's the lesson I hope that we can get through. Cause we're damn well going to need that when we start working out how do we address climate change?
Tracy:
I definitely want to talk about climate change in detail. But before we do that, can you maybe elaborate a little bit on the public debt versus private debt issues? You make a massive distinction in your research between public and private debt.
Steve:
It is ridiculously simple once you see it from the point of view of an accountant, and of course most economists don't do accounting. They don't learn about money. I saw Paul Krugman has a new masterclass program out where the two crucial slides say “Economics is about people. It's not about money.”
Well, that's totally wrong. It is about money and how money affects people and how people affect money. So when you do look at money, you've got to look in double entry bookkeeping terms. And you see what happens when a bank creates a loan? Well, it puts money in your deposit account, which is a liability for itself. And it puts an identical amount of money in its loan accounts saying you owe us that money. So its assets rise and its liabilities rise. And that's how credit money is created by banks and a very similar mechanism applies for the government.
When the government spends more than it takes back in taxes, the spending turns up in private bank accounts. So that rise increases the liability side of the banking systems ledger. And the money is stored in the reserve accounts... is transmitted through the reserve accounts that the banks themselves have at the central bank.
Well, that means the reserves rise when the government has a deficit, just like the loans rise when the private banks create loans. Both of them create money. And in that sense, there is no limit on the amount they can both create. The impacts they both have on the economy depend upon what are the inflationary impacts?
What are the impacts of having to pay for that extra debt? Now, when an individual borrowers money, you can't go to the bank saying, “look, I printed these notes out in my basement. You mind if I use those to pay my interest bill?”
But in the case of the, the government, the Treasury — which creates the money by deficit spending — is the effective owner of the central bank. And that means that it can in fact pay its interest payments, effectively as an accounting operation between the Treasury and the central bank.
So the government has effectively limitless capacity to create money. The limits are the impact of that on the economy, rather than the physical capability of doing it.
But if you look at what are reserves, think about the main assets that the banks have: There are reserves the private banks have at the central bank. There are the loans they've made to the private sector. And there are the bonds that they have bought predominantly Treasury bonds.
Now when the government runs a deficit, it puts money in the reserve accounts of the banks, increases their assets and puts money into deposit accounts. That's where the spending comes from the public gets extra money out of it.
Then the Treasury says we're going to issue bonds to sell the bonds to the banks, to cover the extra debt with with money we've created. Well, the bonds when the banks buy them, how do they pay for them? They pay them with the reserves. So the deficit creates reserves. And then when the Treasury says, “we're going to sell you Treasury bonds for that,” the Treasury bonds earn interest, which the reserves normally don't do. The Treasury bonds can be traded, which the reserves can't be traded.
So it's an offer that's too good to refuse for the banks. And that's why the banks always buy, more than oversubscribe for all the issues of Treasury bonds.
So there's no way there's any borrowing going on from the public in that whole thing. It all happens on the asset side of the banking sector, leaving the private non-bank sector out of it. So there's no limit to the amount of money the government can create that way and cover by bonds. And that's why we saw something like a 30 or 40% of GDP ‘increase’ in government debt. The government created the money that bought the bonds.
Joe:
One thing you mentioned in that, the Krugman masterclass, the idea of his claim, that economics is the study of people or that it's about people. You say it's about money. Can you like explain that further? Like this idea of centering money as the sort of key unit of analysis or like where we start in the journey to understand. What is the significance of starting with money?
Steve:
Let's talk about how Krugman starts without it, first of all, and why that ends up with all the huge mistakes that mainstream textbooks make. And of course
The Bank of England and the Bundesbank have both said that the textbooks are wrong. This is not a raving radical coming out and attacking, you know, sensible centrists economics. This is institutions. And they know what they're talking about, telling the economist, you've got it wrong.
You've got to learn the accounting. So what the economists do, and you can see this in Krugman's work and you can see it in Mankiw's textbook is they say, well, there's a supply of money that's under government control and that's fixed. And then there's a demand for money. And that's both as individuals demanding money and the government, when it runs a deficit, also demands money. So when they show the government running a deficit, they have a downward sloping, demand curve for money.
So the more money you demand, the higher interest rate you have to pay. And the government borrowing gets added onto the demand curve. And that drives up the interest rate. And that's why they make all the arguments about driving interest, government spending, driving up interest rights, crowding out private spending, causing the economy to slow down. That's their analysis.
Now we need to do the accounting and you look at it and I've actually built a software package, which is freely available, called Minsky available on SourceForge. I'd love to have people in the finance sector, as well as academics and students download and take a look at it. And it's designed to do interlocking double entry, bookkeeping tables of the end. A company could do it. with its own books. It's designed for macro economics, it's there as a free tool.
And when you look at what actually happens, what you see is that rather than government borrowing adding to the demand of money, it actually adds to the supply of money. So all the arguments that Krugman and Co make about how deficits are going to crowd out locally to expenditure and drive up interest rates. When you take what actually happens and then put it in their framework rather than adding to the demand curve and driving up interest rates, it pushes the supply curve out and drives interest rates down. So their framework is just completely the wrong framework. And so you've got to start from money. And one of the essential reasons they don't like talking about money is because if you say that bank lending creates money, well nobody borrows for the sheer pleasure of being in debt, you borrow to spend.
So that borrowed money adds to aggregate demand. And then when you have people paying debt off, that causes a collapse in aggregate demand. So if you take on board that banks create money, when they lend and then see what that does to the overall economy, your whole macro economics has to change.
Now, they are quite comfortable with their ISLM models and their DSG and the RBCs and all this stuff, none of which have money in them, none of which have banks. Virtually none. I know one or two. They just don't want to change how they have been used to thinking, even though reality says they're wrong. Now we have the formal bodies, like the Bank of England and the Bundesbank saying they're wrong. So it makes a huge difference to understand the accounting.
Tracy:
So this goes back to the distinction between public versus private debt and, you know, the suggestion or the implication I think is that public debt is much less of a problem in terms of financial stability than private debt. So I'm wondering, could you maybe elaborate on that point and then put it into context for us in the current environment? We just saw massive fiscal stimulus in the U.S. for instance, and at the same time, I think we're starting to see, I haven't looked up the number recently, but I'm pretty sure we're starting to see private sector debt go up. So how much of a problem is that and how much does the balance between public versus private actually matter?
Steve:
Yeah, I think the way to think about private debt and public debt is like a seesaw. Because when you look at the mainstream, they treat them as both the same. Well, they ignore private debt because their attitude is well: Private debt is an act between consenting adults and we shouldn’t look inside the financial bedroom of the economy, whatever they want to do is okay by us. But other government debt, that's a burden on future generations.
Now, in fact, when you look at it, the burden on future generations is when you die with a mortgage and your kids have to take it on later. So it's private debt that gives that burden on future generations of the current borrowers and private debt — when you borrow money from a bank, you can't repay it in notes you invent yourself. Whereas with the government, the government when it spends more than it gets back in taxes, can finance that by accounting operations, between the Treasury, which is part of the government and the central bank, which is part of the government.
So it is in fact, a way of stimulating an economy to have deficit spending taking place, as we've seen during Covid. Imagine what America would have been like if there’d been no increase in the deficit. In fact, the deficit was about 30 or 40% of GDP. So without that spending, it would've been a total collapse in the private sector of the economy. And when you look at the historical record and I've done some empirical work here, but the best work has been done by the philanthropist, American philanthropist, Richard Vague, who's also leading banker in his own right, and now has a formal government position in Philadelphia. Richard did research into one and a half centuries of financial crises in about 150 countries around the world and found over the last 150 years have been about 150 financial crises. Every last one of them was caused by runaway private debt bubble.
And the only way out of it was to write that private debt off. So the whole focus on health of government debt is just the wrong. It's just coming out of bad thinking. And equally one of the things, people, people in also your, what the level of the government data is, is now over a hundred percent of GDP in America after, after Covid, well private debt was 160% of GDP. So the crazy thing is the thing that they told you not to worry about is not only the one you should worry about, but it's substantially larger than government debt in most countries around the world.
Joe:
Okay. So I want to talk a little bit more about the sustainability of government spending, and I think it will actually dovetail or lead us eventually into the climate change discussion as well. But obviously, and as you noted, one of the sort of curbs, or where the rubber might hit the road with the government capacity to spend is inflation.
And right now we have some elevated inflation say in the U.S. but there's a strong argument that, you know, to use the economist word that it’s transitory, but how do you go about thinking more broadly? Okay, forget the data right now, but how do you go more broadly thinking about how to conceptualize ability to spend without generating undesirable inflation or actual like fiscal, you know, how to, you know, reconceptualizing fiscal capacity. Do we have any sort of way to put numbers on this? Or like, how do you go about thinking about where those limits are?
Steve:
Modern Monetary Theory is a description of how current financing occurs, but what we've had is a practice where that's been ignored and you had constraints on how much money government can spend. The whole austerity type programs we’ve had ever since the days of Reagan and Thatcher.
Now, if you say, well, we actually understand it. That would mean that the policy now becomes to get the maximum level of employment. You can get all of your job guarantee as part of that program. And the issue about inflation is that inflation tends to be something which comes out of competition over the income shares of the economy. When we look back the last time there’s major inflation back in the seventies, you had an economy going gangbusters compared to what it's done ever since, low-level of unemployment and high level of capacity utilization.
And that meant a strong demand on raw materials inputs. And you had in ‘73 of course part of the Yom Kippur war, you had the price of oil being increased from $2.50 a barrel to $10, and then you had in 1979, 80 another boom, where the price went from $10 to $40. Well, that takes money out of capitalists’ hands, which means less investment can take place. And you have this slump in the economy. Equally, you had low unemployment. So workers could demand large wage rises, and those wage rises also fed through to inflation. So you need this very, very strong basis in effect in aggregate demand, out of a strong bargaining position for workers to get hold of with the extra bargaining power they get from low unemployment to get bargaining power and demand higher wages. And that's what tends to set off inflation. So in that context where we are right now, we're miles from that happening because the working class unions have been smashed.
There's no real bargaining power for the individuals until you're in a really, really tight market. And we're temporarily seeing that, but I don't think there'll be a sustained follow through of it. But if you did get to the stage where you had a job guarantee, very, very low unemployment people who didn't have lost their private sector job would get a low, lower paid, but still job guaranteed income that would potentially increase the bargaining power of workers.
And you could have struggles over the distribution of income, which could lead to inflation arising. So I think in that situation, you've got to start talking about really instant national agreements, over income distribution, the sort of thing that the Swedish government used to do back in the sixties and seventies, when they dramatically industrialized in Sweden by having sort of agreements between capitalists workers and the government about how to develop a Swedish society at the time.
So, once you realize that you can have full employment, then you also got to have some agreement about the distribution of income and how money is spent. And I'm not going to suggest that it's going to be an easy thing to do. If we actually start getting the government using the capacity it has to generate a level of aggregate demand that gives you full employment, then we're going to have to work that out. What's the power relationship between workers and capitalists in America.
And it can't be as extreme as it's got to be in the last 30 or 40 years. Although we had one little caveat there, it isn't the industrial work that capitalists have got that power. It's the financial system. So we're going to have to take on financial capital. And that always tends to be a lot more fun than you'd like it to be.
Tracy:
I mean, what are the chances that we actually get a real discussion on that issue in the U.S and what are the obstacles to people taking that on?
Steve:
Frankly, I don't think we're going to get that conversation. I've got to take my hat off to Stephanie Kelton and the Modern Monetary Theory, people have been very successful in raising this to the stage where Congress even has debates about it. And you've seen some Congressmen realizing, well, they don't have the constraints they thought they had, and they're changing their attitudes. But the political pressure back in the opposite direction is enormous. So I'm not convinced that we're going to get a conscious decision to go about doing it, but a bit like Covid, before Covid struck like, I'd say December 20th, 2019, if you asked anybody whether the government should run a deficit of 40% of GDP next year, they would have kicked you out of the room. That's what the government ran next year — 40% of GDP.
And if you look back at the last time we had spending on that scale, it was during the second world war. That was when we realized we're in an existential crisis. It was either spend the money or start saying ‘Heil Hitler.’ So we spent the money — nobody discussed that there was too much money being spent buying that next Sherman tank or whatever is being constructed with the government money that was being spent on private corporations to build tanks rather than cars.
So when you face an existential crisis like that, you tend to throw the rule book out the window. And that's when you look at what happened with how people actually involved in doing that. People like Beardsley Ruml and people who were running the federal reserve back in the 1940. They realized there were no constraints on government spending. There's actually a paper called “taxes are obsolete for government spending” by the President of the Federal Reserve of New York in 1946. So that necessity is the mother of invention. Now, if we don't have necessity, ideology comes back in.
So I think if it, if we didn't face any future existential threats, there would be this pressure to return to the old, you know, “balance the books, government spending as a burden on the future,” that ideology would come back. But I don't think it's going to get a chance.
Tracy:
So can I ask the, I guess the flip side of that question, which is, you know, we're talking about fiscal capacity and how do you create appetite to expand that? How do you actually tackle the private debt problem? Because you have this massive financial sector that is incentivized basically to keep creating debt because every time they do that, they earn money. How do you go after that? And like, what is the political appetite to take that aspect on?
Steve:
I think the political appetite is almost zero, because if you look at politicians themselves, the main people, they talk to people in the finance sector. So Eisenhower used to talk about the military industrial complex. I talk about the political financial complex, and therefore what finance wants is what politicians tend to allow. And finance wants to create as much debt as it can, because that's how they make money.
Literally, literally, by creating the debit for themselves figuratively, the more debt the private sector takes on the more income that the private sector has to pay to the financial sector. So their opposition to reducing debt is enormous, but the trouble is we've now reached levels of private debt, which are historic in the history of capitalism. So in America, I've got data in America going back to WIDA 34. And the level of private debt we've got now is greater than the peak level of private debt compared to GDP during the great depression, which was the previous peak driven by a massive deflation between 30 and 33.
So we have this enormous overhang of private debt. And what that means is banks are a bit reluctant to lend because they now realize there's a possibility that wouldn't get repaid. And the non-bank public is reluctant to borrow because they were already carrying an enormous amount of debt, even with low interest rates.
So that combination means you've got very stagnant demand coming… when credit is part of a small amount of credit demand is a healthy part of a growing economy. But if you look at Schumpeter. He argued in favor of the private banking system. The main argument he made was that banks should be providing money to entrepreneurs. Now they don't, but that's what they should be doing.
So what we've got is a huge overhang of private debt. We shouldn't have led private ticketing, anything like level it's at, I think it would show just at 170% was the peak when America was during what we call the golden age of capitalism between the late forties and the early seventies, the level of private debt began at about 40% of GDP and something between 40% and 70% of GDP pay that's money.
You've borrowed through recent, for realistic reasons. You've got working capital for companies. You have money for households to buy large consumer items. You have some funding of entrepreneurs. That's a creative role of the financial sector. When you get to the 170%, you can regard that a hundred percent is pretty much parasitic behavior. And what I proposed I've done a Minsky model of this could actually work. We needed a modern debt jubilee. We can't just write the debt off because that would cause the banking system to collapse.
We can't just give money to people who borrowed money from the banks and say, pay your debt off with that. Because people who didn't borrow people who were frugal you know, that's a moral hazard, where's mine. Well, my agreement is let's use the capacity of the government sector to create private money and use a gov government money fiat-based money and use that to replace credit-based money.
So you give everybody in the country, every adult, the same amount of money. If they have debt, they must pay that down off their debt. If they don't have debt, what I would require is that they buy newly issued corporate shares, where those corporate shares are used to pay down corporate debt.
So they could reduce both household debt and corporate debt quite substantially. You wouldn't change the amount of money in the economy just changing from being mainly being by credit and private debt. It's now mainly backed by fiat and government money creation capability. And with that, you would dramatically reduce the inequality that we've got in society.
You'd also stimulate the economy, because there's more workers than there are bankers and capitalists getting the same sum per head. You'd stimulate the economy because workers have to spend faster than bankers or capitalists do. I've modeled quite a substantial boost the economy with no additional money creation. So we could do it and I'm certain we won't.
Joe:
Do you have a dollar amount? In the U.S. like how would one go about deriving the right amount?
Steve:
I wouldn't necessarily do it in one shot, because unlike standard economists, I'm not confident in my mind that it's going to work magically. So I'd like to do a test run. But if I did the whole caboodle, the model that I did was giving every adult American a hundred thousand dollars over one year where a hundred thousand, as I said, if you're in debt, had to be used to pay debt down. If you weren't in debt, you had to buy corporate shares, which we’d use to cancel corporate debt. Now that worked out to a hundred thousand dollars per person, which is about 110% of GDP. And if we did it, we'd reduced the level of private debt from 160, 170% down to 60 to 70% of GDP, which is back on the sweet spot for the golden age of capitalism.
And that of course would mean a shift in the allocation of debt. So private debt would fall, government debt would rise, but when I modeled it, the result I wasn't expecting was because this meant there was much more money in the hands of workers and middle-class people than beforehand, the economy went into a boom and the boom meant the debt ratio fell.
So we’re not worried about the level of debt, we worry about the ratio to GDP and the impact in my model, the impact of this hundred thousand per person was to first of all, boost government debt by a hundred percent of GDP and drop private sector debt by the same amount, but over the next 10 years or so, the debt dropped back to — you had a hundred percent fall And the level of total debt premium from side is about 260 data, 160%, 60% private debt, and a hundred percent government debt. That was a reduction in the debt burden.
So it's a way of doing it hat would actually work and stimulate the economy. It would cause more profits for firms. Even the bankers could come at a tie because if you sold Jubilee bonds to finance it, the interest rate on the Jubilee bonds could make up for the fact they weren't getting interest on the private debt that had been canceled by the modern debt Jubilee. So it's all doable. I just can't be a hundred percent short what happens.
Tracy:
So we were talking about attitudes towards fiscal spending and how they might be changing, but possibly, not to the degree that you'd be advocating Professor Keen, but I know you've been critical of the European Union over the years. And I'm curious how you feel about it now and whether or not you see some attitudes changing towards fiscal cohesion.
Steve:
The European Union was a good idea. The euro was a big mistake, and that might as you, and that hasn't changed because the whole logic I'm talking about of private and public debt assumes you have a Treasury and a central bank that can back whatever you do with your fiscal policy. Of course, when the countries of the European Union formed the euro, they gave that right away.
There’s no supranational central bank. There's no supranational Treasury, there's no supranational spending. So in that sense, all those governments have turned themselves into effectively being in the same situation as a borrower. And we're seeing how disastrous that's been particularly for Greece, but also for Spain and Italy and Portugal.
The beneficiaries have been the ones who've got, like Germany, they did very, very well, thanks very much, out of the fact that countries like Italy could no longer devalue their currency when they had a trade deficit with Germany. So I'm still a critic of it. And of course, when you see how it, first of all handled the Covid outbreak and then the vaccine rollouts, and then the odd year of providing people with money to enable them to pay their financial commitments when they couldn't go to work because of COVID, it was, it was, I was going to use the word starting with cluster and ending with duck.
We'll try to avoid it, but it did nowhere near as well as America, which is always the model for the European union or even U.K. at that stage, even though the U.K. managed to stuff up Covid royally. So I'm no great fan of it.
But what I have seen is that, again, experience is teaching them some lessons, all the things they were worried about happening out of large levels of government spending haven’t occurred. So in that sense, there's been a bit more realism creeping into the European Union, but it's still one of the first things I would do is go back to the lira, go back to the peso, go back to the mark, and just use the euro for internal trade in the European Union. But again, they seem to be so wedded to the idea of this supranational currency, that that's, again, not quite as unlikely as a modern day Jubilee, believe it, unfortunately pretty unlikely.
Joe:
You know, before we delve a little bit into the climate discussion. And obviously it's, you know, it's part of this discussion. I wanted to go back to something you said about the politics of full employment. There's that famous essay on the political aspects of full employment by Kalecki and he sort of anticipate what you talked about.
Okay, if the government were to ever really be in permanent fiscal stance where it's always going to maintain aggregate demand, such that we're have full employment, somehow that's when the real political fight begins. And of course, we're already seeing that. I mean, we're nowhere near anything resembling full employment in the U S right now, we always see already some major pushback against UI major frustration among companies at their ability to hire easily right now. Like how brutal could it get? You know, as we get to, as labor markets get tighter and tighter, what do you expect to see?
Steve:
They could well and truly try to do that. That's definitely the case, and it could be quite destructive of the stability you're trying to bring about through MMT to begin with. That's why I think you've got to include the idea of an income compact at the same time as part of it. It's also why I focus on not just looking in terms of workers versus bosses, but workers versus bosses versus bankers, because where the real — and this is sensible in my mathematical modeling of what I call the Minsky's financial instability hypothesis.
One thing which came out of the model was that the rising level of debt, where I had had firms borrowing money to actually invest in real factories. So it was the sort of borrowing for the sort of reason you'd want to see, but you could have such a level of euphoria during a boom that capitalists borrow more than they could repack during during the slump.
And you got this ratcheting up of private debt, and you finally had a debt crisis, but a side effect of this was, again, was not built into the models. What's called an emergent property. Is that even though it was the firms. Therefore the capitalists doing the borrowing and the workers had no borrowing at all, it was the workers who paid for the higher level of private debt because increasing that level of private debt led to a falling workers’ share of income. So the transfer of money wasn't from firms to bankers, it was from workers to bankers and the firms were sitting in the middle. So I would want to reduce the power of the financial sector and say, if we make the financial sector less powerful, less of a burden on both households and firms, both workers and capitalists can benefit from that.
We've got to reduce the size of Wall Street. Wall Street is a burden on American capitalism, not a shepherd to a golden future. But nonetheless, I can just see if you had full employment and you had the animosity that exists now between American workers and American corporations after last 30 or 40 years, if you gave power to the workers by having full employment, there could be a lot of ‘we're going to get even now’ type attitudes amongst workers, in terms of, you know, you want me to come and work for you, pay me more money. There could be those, those things leading to a conflictual approach, and then coming back and trying to screw the bargaining power of the workers by bringing back unemployment once more. So by no means, do I see a rosy future where everybody's holding hands and singing kumbaya. This could be, unless it's done sensibly, you could have an outbreak of political conflict coming out of the change in the power balance, the appreciating of what MMT means about government spending and the capacity to generate full employment actually means.
Tracy:
Okay. So speaking of non-rosy futures, that's probably the perfect segue to finally talk about climate change. So you have been incredibly interested in this topic and also incredibly scathing when it comes to some other economists’ work on the actual price or cost of climate change, including a certain Pulitzer Prize winning economist who’s done a lot of work in this space...
Steve:
Pulitzer Prize is close. It was a work of fiction but it’s actually the William Nordhaus Nobel Prize, which itself was a work of fiction because it's not a Nobel prize. But it’s a great line, No I think we stick with that. Pulitzers are great ‘cause actually it's a work of fiction. The Nobel prize in economics is not a Nobel prize. And what the Nordhaus does is far more fiction than anything related to fact.
Tracy:
That's my media bias showing here, I'm entirely focused on — one day, Joe, a Pulitzer for Odd Lots. Okay. I have a bunch of questions on this, but like one why your intense interest in the space, and secondly, what is it about traditional economics in your opinion that makes it ill-equipped to deal with climate change or to model it properly?
Steve:
Well, the first question I've been fascinated by how we actually include the physical reality of production and the economic models ever since the seventies, when I first became a critic of the mainstream economics. And of course at the same time limits to growth came out, which I thought was a superb piece of work. I understand system dynamics. And I was doing mathematical studies at the time. So I thought it was superb and then economists trashed the hell out of it. And the economist who did the most to trash it, was one William Nordhaus who wrote a paper called ‘Measurement Without Data.’ So that was the beginning of my interest. I didn't engage in the academic work on it until 2016 or 17 when I was working with some economists, a guy called Bob Ayres who’s a physicist who's been trying to bring energy into economics for a long, long time.
And then we were working with Bob. I was saying, how do we bring the role of energy into how economists think about production? Because if you look at not just the way that neoclassicals do, but even my more realistic post Keynesian school of thought, they model output as being generated by labor and capital. Now you can't produce anything without energy. So the fact that it wasn't there just didn't make any sense to me.
And the question is, how do you bring it in sensibly? And what would happen if you look at work by Stiglitz and Solow, two very mainstream economists back in the seventies, they said, well, let's just add energy in is another factor of production. You know, you put labor and capital and energy together and you get output well. Yeah. Okay. I'm going to throw a hand grenade into a factory and see how many widgets I can produce that way.
You can't just add energy like you could machines or workers inside it and walking through Bob's house one day, which is full of statues, that little flash of insight popped in my mind. Labor without energy is a corpse capital, capital without energy is a sculpture. In other words, energy is needed as an input to both labor and capital to allow them to do work. 10 minutes later, I'd done this idea of bringing energy into models of economic models of production.
So I thought with that done, the paper was published in 2019 with the innocuous title of the A Note On The Role Of Energy in Production. I thought it was time for me to engage in this discussion about climate change. And then in 2019, Nordhaus got the so-called Nobel for it. Well, my initial reaction was at least they're giving a Nobel prize for environmental work, but then I thought I'd better read the literature. I always dive in. Even if I can't stand neoclassical economics, I still read it.
And I couldn't believe that the garbage I was reading, quite frankly, I'm not going to be polite about this. This is the worst work I've read in 50 years. And the fact that it was given a Nobel Prize is not a reason to trust the research. It's a reason to shut the Nobel Prize down ant to shut mainstream economics down as well. It's that bad.
Joe:
So what is it for people who aren't familiar with the work? Once you've dived into it? What are the claims that Nordhaus is making that you think are so discrediting of the Nobel Prize?
Steve:
Well, the main claim that he makes is how trivial the impact climate change is going to have on the economy.
So in his Nobel Prize speech, which people can find on the web quite easily, he said that with no abatement of the impact of climate change, just letting the economy roll on. If there were no damages from climate change at all, then you get a certain level of GDP. If you include the damages from climate change on our productive capabilities, a six degree increase in temperature would cause an 8.9% fall in GDP — six degrees temperature. That's published in the paper, in the American Economic Review. One of those specialist in 2019, I think, and in his Nobel prize speech, he actually says the optimal temperature change is a four degree increase in temperature over pre-industrial levels
I just, I couldn't believe it. How the hell does he reach those results? So I dive into his research and there's a particular paper in 1991 called ‘To Slow or Not to Slow.’ And in that he assumed, simply assumed, that 87% of industry would be unaffected by climate change because it happens in what he called carefully-controlled environments. He lumped all manufacturing, all services, all of government spending, he even lumped mining in there. The only thing those things have in common is they happen under cover, except he didn't ever think about open cut mining, obviously. He's simply saying a roof will protect you from climate change. Well, I'd like the people of Alberta and Calgary and Vancouver and Spokane to come and have a conversation with William Nordhaus about how much a roof protects you from climate change.
It is an absurd assumption, but this is what economists do all the time. They make what they call simplifying assumptions, which actually, if the simplifying assumption is a genuine simplifying assumption is false. You have a slightly more complicated model. Okay? If these assumptions are wrong, the whole world is different and that's the sort of assumption they defend as simplifying. So he did that. First of all, he said of, you know, simplifying assumption that a roof will protect you from climate change.
And then another one he did was say, well, we can use the current relationship between temperature and income across the United States to say, what's going to be the impact of climate change as if what we're experiencing now in terms of before climate change hit — the fact that Florida is poorer than New York and New York is richer than North Dakota — the temperature differences there, he said, you might get a 10% increase in GDP if you moved from North Dakota to New York and a 10% fall if you go from New York to Florida, that's all that's going to happen if we have a six degree increase in temperature to get us from North Dakota to New York and another six to get us from New York to Miami, that is insanely stupid. And those assumptions are an essential part of coming out and saying that a six degree increase in temperature will only reduce GDP by 8.9% I think it was. It will eliminate our species. That's closer to what the impact will be.
Tracy:
So there's something you said there about traditional economics not dealing that well with the physical, and this is also something we've been talking a lot about, like this idea that for instance some classical ideas of the benefits of free trade, for instance, and competitive advantage, don't actually take into account transport costs.
So in a year like 2020, when we suddenly see borders closed and gridlock in shipping and shipping costs going up quite a lot, classical economics isn't well equipped to deal with that or to work around it or to sort of synthesize it. I'm wondering, are you looking at that aspect of the economy as well? Like this idea of things being more complex than traditional economics has allowed? Is that something that 2020 has proven in your mind?
Steve:
Oh, well and truly, yeah. I mean the whole idea of the fact we've got these incredibly long supply chains up to a hundred countries involved in manufacturing an Apple iPhone, well the Apple iPhone stops being made when Covid hits . There's an incredible fragility in the economy we've designed to make it incredibly efficient. Efficiency is the enemy of resilience. An efficient bear has no fat when it goes into hibernation and therefore starves.
So you have to have buffers, you have to have surplus resources to be available, surplus beds, for example. So when a pandemic hits, you've got room and extra intensive care beds, instead we're seeing the panic we've been through because we trimmed it down to the stage where there was only slightly more supply than you would get from demand in a normal situation.
Normal, it doesn't exist anymore. So yeah, it's incredibly ignorant about the physical world and this is why they can make the stupid assumptions they make about manufacturing — all you need is a roof to protect you from climate change.
Well, if you can't get energy, your machine stopped turning, if you can't get workers, because the temperature where you're living is simply incompatible with human life, there'll be no workers to manage those machines. So there's a physical unreality to mainstream economics. And that's why I'm part of another group called the Institute for Biophysical Economics, trying to say, we have to build a physically grounded biologically realistic model of the economy because we certainly haven't got it now. And that's why we've led ourselves up the climate change garden path.
Joe:
Yeah. I want to talk more about that because you mentioned this idea that physical capital about energy is it is a statute, which I thought it was a really nice way to put it and that we can't just wrap in energy as yet another physical capital factor of production. What happens when you introduce energy into the equation? So as you described, if we need to labor, capital and energy, what are the new outputs when you break out the models this way?
Steve:
For example if you know what they call the Cobb Douglas production function that the mainstream uses, one of the mysteries they've had for a long time is that attributes output to being a factor of technology times labor times capital and they always thought that labor and capital would be the main sources of change in output, but they find it’s actually technology and they call it what they call the Solow residual.
Now, when I put my energies and inputs of labor and capital into that function, what I get is that the so-called technology, which it still is obviously a form of issue. Technology is the energy consumption level of the typical machine of a particular generation. So if you look at the energy consumption of a James Watt steam engine, that was about 10 tons of coal per day.
If you look at the Elon Musk's Falcon rocket, that's about effectively 10 tons of kerosene per second. So that's where the dramatic increase in income has come from. We really are benefiting out of, you know, all of us work as workers, capitalist bankers, the works, are benefiting out of using far more energy for production, but what that then gives you is well, how sustainable is that? And when you have energy as an input to production, in this sense, you also get the necessity of both waste energy and waste materials. You can’t produce output without energy and matter. You therefore can't produce useful output without waste energy and waste matter dumping into the environment. So you then have a link between the economy and your ecology. And of course, the question is, you know, there's many, many questions out of it. What is the impact of using all that energy and using all that matter on the sustainability of the ecosystem?
And you would be thinking about that rod from the outset. We have been completely blindsided by that over the last 50 years. And in effectively two generations of humans we've tripled or quadrupled our load on the planet. And that's where we're saying things like the impact of climate change, driving up temperature. Carbon dioxide is one of the forms of waste we dump into the environment. And we're now seeing the impact of that in an incontrovertible way in Canada right now. But you therefore have to think in terms of the physical constraints of the production system on a planet, and we have completely ignored that. And we're now paying for it.
Tracy:
Given that framework, what's your solution for it then? Because of course the challenge here is always that, well first of all people don't seem to appreciate the physical aspect of economic growth, but secondly it's that sort of classic commons problem, right? Where everyone can abuse the environment because they individually benefit from it. So how do you actually fix that?
Steve:
Well, I think we could've fixed it. If we listened to the ‘limits to growth’ arguments 50 years ago, we could have fixed it gradually using market mechanisms like carbon taxes and carbon pricing. That would have been feasible and also constraints on population growth and a whole range of other issues that when the limits to growth did their simulations.
I had about, I think about 14 simulations and three or four of them led to a sustainable future where we continued having up to three times the standard of living, the average standard of living they got for the whole planet was about three times the standard of living of an American in 1970. And since Americans in 1970, most of them aren’t better off today than they were back in 1970, given the skew and income distribution, that'd be a pretty darn nice world. Now instead because we have delayed for 50 years and trebled or quadrupled the load on the planet, I think we're in massive overshoot and to get to a sustainable level, we've got to go backwards.
We have to have what people are calling de-growth and we're not going to do it voluntarily again. I think we'll do it because we're forced into it with events like the Canadian heatwave and worse to come. That will be something which has to be done by a command economy. You can't do it using market mechanisms. So I think in that sense, we’ve got ourselves into another war, but it's not a war on climate. It's a war to restore the climate. And that means it’s really a war on our over-consumption on the planet. And, you know, the only way I can see it happening is if people truly realize that this is an existential threat, not for their children or their children's children, it's an existential threat for anybody alive today.
Joe:
I'm thinking back to the beginning of the conversation and there has been like there's big turning point, perhaps from a fiscal perspective in rejecting austerity. And you pointed out too, that at times of like extreme crisis, such as prior to wars, necessity changes people's perception of like what the government is capable of doing.
And I think that like, you know, right now the political debate around climate, there seems to be a lot of impulse to address it, but not a lot of impulse to do what you've just described, which is essentially a form of de facto austerity not about fiscal sustainability, but, ecological sustainability. How do you build the politics though, for what you're describing as something of an austerity regime.
Steve:
It won't be done in any voluntary sense. Most people, frankly, aren't interested in economics. So I've got used to that over time, it's only obsessives like us who really want to know how the economy operates at all times. Most people are a bit like me with a car. I only want to know how the energy works when it stops working.
I open the car and turn the engine on and draws where on going and turn it off again. And I don't think about all the complicated mechanics involved in making that possible. So the same thing applies to the economy for most people and therefore they can't see any need to restrain their own spending. They, won’t voluntarily turned vegan. They won’t voluntarily walk rather than hop in the car and drive to the local shop.
It's going to be something I think, holy hell, if I don't do that, we're all going to die. Now, if you look back to the Second World War that realization hit England when they had to suddenly evacuated what was left of their army out of Dunkirk, and you had a very rapid procession, Poland falls, France falls, and suddenly they’re like this is serious, we've got to throw all our resources at trying to defeat this enemy. And then in that situation, people accepted rationing.
Now I think the same thing is going to apply here. We are going to need some serious crises. And then when it does, people will suddenly realize this isn't something for two or three centuries in the future, which is what William Nordhaus literally says. He says limited small damages, relatively small damages in the next two centuries.
That's in one of his published papers. It's not relatively small damages. They’re huge damages they'll be coming, if we're lucky, in the next 30 years, if we're unlucky in the next 10, and when that realization hits, then it's an existential threat. Then in those situations, people are willing to accept constraints on what they can do to drastically reduce our level of consumption and to give us some possibility of throwing our resources, rather than producing, you know, more and more plastic furniture. All this junk we consume.
Drastically reduce it, just essential consumption and all our resources are directed at creating non-carbon generating energy systems and reducing our load on the planet, trying to restore the biodiversity to restore the things like the Arctic, which we're obviously losing the Arctic summer see ice we’re losing right now. Everything has to be going to back to trying to restore the stability of the climate that we have destroyed, where the hollow sane climate that we evolved our societies, and we've got to rebuild that for our societies to be able to continue existing. Only once that realization hits, I think will anything be done. And in that case, we're not going to be, you know, getting there ahead of it. We're going to be in catastrophe catch-up mode. I want to say it happened as soon as possible, just so we reverse direction before it gets even worse.
Joe:
What about what the liberal optimists would say. That nuclear power and carbon sequestration and other technologies can address some of these things without the sort of like extreme austerity regime that you're describing.
I assume you're skeptical of those paths, but I'd like to hear why.
Steve:
Yeah. I mean two reasons: first of all, where's the engineers for this. I have a lot of engineers on my Patreon website and some of them are totally pro-solar and some are totally pro-nuclear and I've come out in a balance of both saying yes, if we had a well-designed energy system, we'd have both nuclear and, you know, things like thorium reactors rather than uranium, but those and lots of solar power and wind as well. But the reality is we haven't produced one Thorium reactor since the very first trial one was done before America scrapped thorium for uranium reactors, because that way you could make nuclear weapons.
So we simply don't have the technology or engineers able to produce them as rapidly as we need to. And then it's actually easier to produce the solar power because it you know it's so long as we can make the solar cells out of the factories, the work of installing them is trivial compared to the work of building and installing authorial nuclear reactor.
So in that sense, I see solar as a more immediate way of addressing our need to get away from coal, but the other trouble is it isn't just carbon dioxide. The whole focus on carbon docks that actually suits to some extent the climate change trivalizers like Bjorn Lomborg and Nordhaus and all that mob, because it's leaving out things like our impact on biodiversity. Now you might, you may ended up saying this was a segment recently on ocean snot.
Ocean snot off the coast of Turkey, huge disturbance to the bio biological patterns in one of the in the ocean between the Mediterranean and the Black Sea, and this is the sort of damage we're doing by the runoffs. The fertilizer runoffs we're putting into the ocean. The way we're wiping out species that layer of snot is in some places apparently up to a meter thick. And it means that any fish are going to starve and lose oxygen and we're going to have mass die-offs. So it isn't just the carbon. Isn't just the energy issue. It's the whole pressure we're putting on the biosphere and we have to restrain ourselves in ways that humanity in general — it isn't just under capitalism — Humanity in general has never practiced restraint. And until we do, we're not going to have a sustainable future on the planet.
Tracy:
I'm sorry. I have one more question. Based on that, but a big part of our conversation has been, how do you change attitudes, whether it's towards, um, fiscal capacity and the deficit or towards climate change or towards the relationship between capital and labor, what do you think is needed to change or to shake up classical economics and maybe change the way, um, economists are viewing a lot of these issues?
Steve:
I think economists are a lost cause, frankly, because once you believe this stuff, it's a self-contained belief system, and this is not just being critical of economists. It's something about humanity as well. Max Planck, who is the guy who discovered quantum mechanics by solving what was called the black body radiation problem, using complex mathematics, he realized that part of the solution involves energy, being discrete, coming in what we now call Quanta rather than being continuous, which was the assumption of the Maxwell physicists that he was raised Southern all these colleagues were Maxwell and physicists. Now he tried to persuade his fellows that, you know, they had to think of energy and discrete units of Quanta rather than being smooth. And they simply couldn't do it. And he finally wrote a wonderful line, which is summarized by saying science advances, one funeral at a time did that works in sciences because the experiments that prove that the Maxwell thing didn't work, you can do those experiments and get exactly the same results you can reproduce.
What scientists did back then to find that the all theory doesn't work. And so when students come in and they've got these professors who was still teaching them, the old stuff, but these students are aware of that the old self doesn't solve this new problem. And so when the professors get to the size, they've got to replace themselves, they retire or they die. They've got to hire new staff, students as staff. And those students are dedicated to the new way of thinking. That's why science progresses one funeral at a time, but an economics you can have across as like the great depression. And it becomes a history. Nobody knows about it. You can't reproduce the great depression. We have the great recession. You can't reproduce that and see whether a post Keynesian approach would have worked better than a neoclassical approach. So we tend to forget history.
We forget the experience we've done in the real world in which we live. And then new people come along and get taught by those same old neoclassical lot. And the neoclassical vision is a beautiful vision of a faculty in Aneka society with no power, it's corrupt, everything and where there's no need for government. It's all done by the market. And it's all nice and anonymous and egalitarian. And that is such a seductive vision that these nerds who come along and fall for this stuff end up, reproducing it again. You can't get rid of them. So I, I, he saw economics does not progress one funeral at a time. We have to replace it, lock stock and barrel, and I'll be sending these economists off to go plant trees somewhere, or maybe teach a few mathematics classes, history students, rather than you do. You can't convince them. You can't convert them. They'll be the last people to realize the world has changed.
Tracy:
Professor Keen, an absolute pleasure speaking with you. Thank you so much for coming on Odd Lots and a really fascinating conversation. So thank you.
Steve:
And thank you for the thought of it. I had a lot of fun, I hope it wasn't...It got a bit hairy. There had to have it. Didn't get too hairy.
Joe:
No, that was great. We really appreciate it.
Steve:
Good. Okay. Great.
Tracy:
Really good. Thanks so much. Cheers.
So Joe, really a fascinating conversation and there are so many bits and pieces to pull out of it. One thing I really liked, well, in addition to professor Keen's emphasis on the physical, which again has been one of our themes for this year, this idea that economics actually doesn't do a very good job of taking that into account, but I really liked the distinction between public and private debt.
And if you just look at the way the world works, it's absolutely true that like classical economics seems to put much more emphasis on public debt than it does private debt. Like even if you look at the European Union and things like the Maastricht Treaty, that is all about constraining government debt, and it doesn't say anything about private debt.
Joe:
It's incredible how backwards so many people's intuitions are about are about that. I mean, it couldn't be more spot on there's so much as you say, the Maastricht Treaty embedded in the law, this idea that like the public debt specifically must be contained so much, you know, fear-mongering about a fiscal expansion and having to pay for it.
It's almost like it's, it really feels like it's 180 degrees backwards. When you look at any crisis, how often it originates in the banking system, the private sector, household debt, and so forth. It's kind of like amazing how consistently backwards a lot of people's intuitions are about this.
Tracy:
Totally. And I'm just thinking back to like Spain during the eurozone crisis, the problems that were entirely on the banking/private debt side. And meanwhile, the EU is sort of wringing its hands over government debt ratings and things like that. And fiscal austerity it's — I kind of wish I'd known of professor Keen's work back in, you know, I guess 2012, like that would have been a really helpful framework for actually viewing the eurozone crisis
Joe:
A hundred percent. And like I've said it many times. It's so like, I do think that within sort of more like intellectual economics, economic circles, there does seem to be a certain sneering at accounting. That that's for the person who balances the books in the back offices. Who is it? I think Stephen Clapham that we talked to? So many of the most interesting conversations we have are rooted in accounting.
I want to just, you know, like going back to like the, the climate portion, because it's really interesting. I do feel like there is a lot liberal climate optimism that it's sort of like, we can get two things done. The green new deal implies a new deal: everyone gets jobs and it’s green. We can do it in a way that’s ,you know, environmentally friendly and professor Keen's message is at this point. And I think, you know, no one wants to hear it. And I don't know. I don't have an opinion whether it's right or wrong, but no one wants to hear that as essentially like the only message like extreme austerity is the answer to the sort of, to ecological crisis.
Tracy:
Well, it's again sort of totally at odds with classical economics, which is all about economic growth and then suddenly you switch into, well actually in order to save the planet and ensure that we all survive in the long run you have to restrain growth. I don't know. And yet you kind of made this point, but yet people seem comfortable sometimes, or at least in classical economics, people seem comfortable with the idea of fiscal austerity in order to preserve the budget. And yet, like there seems to be a lot of difficulty with the idea of fiscal austerity in order to save the planet and preserve the planet.
Joe:
Or just sort of consumption austerity more broadly. It's like fiscal expansion, consumption austerity. I loved. Um, and again, I thought it was a very interesting phrasiology or characterization like neoclassical economics as actually like a defective form of like anarchy. And I hadn't really thought about that before, but if you're sort of like assumption is that in this sort of like the natural state of nature is for things to come into balance, right? To, for things to come into balance that two lines intersect on a chart and there's the price. And if we just let that happen, then everything balances out. We just sort of like what neoclassical economics is rooted in these assumptions of equilibrium, but that is also like implicitly anarchist because then the best the government can do at that point is create distortions and create, you know, or maybe necessary, but unfortunate distortions in what would otherwise be this perfect harmony is sort of this very interesting anyway, fascinating provocative, conversation with Professor Keen.
Tracy:
Yeah, absolutely. It reminds me a lot of that, the anarchy point reminds me a lot of that quote about, you know, ‘Things fall apart. The center cannot hold.’ Okay. Should we leave it there? All right.
Joe: Let's leave it there.
You can follow Professor Steve Keen on Twitter at @ProfSteveKeen.
Transcript: Steve Keen On What Economists Get Wrong About Everything - Bloomberg
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